Twelve common portfolio problems (and how to solve them)

A closer look at some of the common issues and challenges which all investors face

Ever played golf? Taken a yoga class? Tried your hand at painting, or playing piano? If you have then, in an unexpected way, you’ve got a pretty good idea of what investing is like: it’s as much a journey as it is a destination. It takes considerable time (years, or even decades) to learn how to do it right. There’s always something more to learn. And the idea of “perfection” is something to aim for, rather than achieve.

Truth be told, there is no such thing as a “perfect” portfolio. Even for professionals. Much like PGA pros, yogi gurus and famous artists, the “pros” of the investment world are constantly trying to improve both their skills and their portfolios, dealing with investment issues, problems, challenges and “stuff” that needs to be fixed, tweaked and worked upon. That’s even more true after the pandemic year that we’ve just been through, during which plenty of external factors (economic downturns, market volatility, changes to tax laws, etc.) have thrown even the most carefully constructed portfolios out of whack.

But here’s the good news: most of the problems which we might encounter with our portfolios are fairly easy to identify and fairly easy to fix, too. With that in mind, here’s a rundown of some common portfolio problems, along with some practical tips and suggestions regarding how to fix them, so that we can make our portfolios as efficient, effective and hassle-free as possible.

Problem: you have a hard time following your portfolio

No, you don’t need a PhD in finance to be able to be a successful investor − investment success has always been more about your stomach (ability to handle emotions) than it is about your head (how smart you are). Even so, the complexities of certain stocks, geographic markets or whole asset classes aren’t always easy to understand. Depending on the size and complexity of your portfolio − both of which tend to increase as we invest through the years − some investors reach a point at which they have a hard time understanding what’s really going on in their portfolio.

Solution: focus on what you understand

We’re advocates of the Buffett approach here: stay within your circle of confidence. If you can’t get your head around a certain business or industry − if you scratch your head when reading about what software companies do, for example; or you have no idea how the marijuana market works; or you just don’t “get” bitcoin (truly, who does?) − then it’s a good idea to take a pass and focus instead on businesses and assets which you find easier to understand.

Of course, one way to get around this problem is to invest in mutual funds or exchange traded funds (ETFs) with professional oversight. If you still choose to invest in individual stocks, stick to well-known, well-managed companies with long-established business models that are easy to understand. Canadian banks would be a good example here. Or railroads, maybe. Or real estate investment trusts (REITs). Such companies have been around for a long time, and make their money in ways that even grade-school children can comprehend.

Problem: you haven’t taken a close look at your portfolio in some time

You know what happens if you don’t mow your lawn or weed your garden: pretty soon, it becomes an overgrown tangled mess. The same thing can happen to your portfolio. While there’s nothing wrong with a “buy and hold” strategy, if you neglect to trim, prune or weed the positions in your portfolio, it could become overgrown with risk. Failure to check in on your investments on a regular basis may cause you to miss business and economic events that may significantly impact your holdings. And, over time, the routine ups and downs of the market might throw your portfolio out of whack with your allocation objectives or your risk tolerance.

Solution: set up a regular portfolio checkup schedule

Much like you tend your garden on a regular basis, you should schedule routine portfolio checkups, too. How often? Well, routine market-watchers might want to check in every week, or even every day. For those of us who are more hands-off with our investments, a quarterly checkup is probably a good rule of thumb, with additional “emergency” checkups if a market-shaking event strikes (the meltdown of last March would be a prime example). This doesn’t mean that you should always take action. But, at the very least, it will force you to actively monitor your positions, and help you identify small problems before they become big ones.

Problem: risk is “creeping” into your portfolio

A significant problem, although one that can be hard to see until it’s too late. Even novice investors understand that the various holdings in their portfolios will rise and fall in value in any given year. But, in times of continued broad-market strength (such as what we’ve experienced since March of last year), risky bets can seem a lot less risky than they really are − if everything is going up, you don’t really notice the potential for loss. Over time, however, this kind of complacency can mean that your portfolio “creeps” away from a level of risk with which you’re comfortable. It’s only after the position drops by 20%, 30%, 50% or more in a few short weeks that you realize that perhaps you aren’t really cut out for “theme stocks,” high-flying tech startups or other high-risk/high-return investments.

Solution: do an honest assessment of your risk tolerance and trim, if necessary

If it’s been a while since you’ve assessed the “riskiness” of your portfolio holdings, it’s time to do so. One way is to run through various “what if” scenarios, in order to get a better idea of exactly how much of a loss you’re really comfortable with. If you start to cringe a bit at a particular dollar figure − and you should think about it as a dollar figure instead of a percentage, which tends to be more abstract − then you know that you’ve reached your limit, and it’s time to trim back those risky bets.

The key word here is honest. If you’re not truthful about your appetite or limit for risk, or if you try to convince yourself that you’re “stronger” than other investors, or that you can control your emotions under a high-stress market crash in which the value of your holdings drops by 33% in the space of a month (about the size of the market drop in March of last year), you may be in for a very rude awakening if one of those “what if” scenarios becomes reality.

Problem: portfolio returns aren’t keeping up with the market

We all want to see our wealth grow over time. But, when we notice that our returns aren’t keeping up with the broader market, we can sometimes feel as if we’ve missed out on something − that we’re doing something wrong or not getting what we paid for with our investments. This emotional reaction can lead to a whole host of other problems: we might make riskier investments or ignore long-term planning goals, all in a misguided effort to “beat” a benchmark or goal that we’ve set for ourselves, or make up for some of those “lost” returns which we think we’ve missed out on.

Solution: think about risk-adjusted returns

Performance is all well and good but, to get a real understanding of how your portfolio is doing, it’s better to focus on risk-adjusted performance − that is, how much performance are you getting compared to how much volatility you have to accept in order to get it. (Remember: there is no such thing as truly “risk-free” performance.) There are many ways to measure risk-adjusted performance; some common ones include alpha, beta, R-squared, standard deviation, and the Sharpe ratio (named after the Nobel Prize-winning economist who invented it). There are many online tools and websites that allow you to track at least some of these measurements. Getting familiar with them allows you to get a true measure of the performance of your portfolio, so you can make apples-to-apples comparisons to whatever benchmark is most appropriate.

One final word about performance comparisons: we’d question how much attention investors should really be paying to them at all. For many investors, beating a benchmark is just a way of bragging about one’s portfolio − an emotional response that completely misses the point of investing. Instead of trying to beat a benchmark, ask yourself: have you earned enough to fund a high quality of living for the rest of your life? Do you have enough money to cross items off of your bucket list? Will you have enough to leave a meaningful financial legacy for your family? These are the real benchmarks against which you should be judging your portfolio.

Problem: your portfolio is too “Canadian”

Keeping your money invested primarily in Canadian securities can make some sense: most of us are much more familiar with Canadian stocks, for example, and as Canadians, most of our ongoing expenses will probably be valued in Canadian dollars as well. However, too much exposure to Canadian investments can mean that you miss out on other areas of the world economy which are growing much more strongly. It can also leave you exposed to some of the idiosyncratic risks that may affect the Canadian economy more than others: a slowdown in commodities, for example. Or a run-up in the technology sector (Canada is home to relatively few tech stocks). Or a broad pullback in the price of oil.

Solution: include investments from other parts of the world

Despite the increasing interdependence of world markets, performance can still vary a lot from region to region. Having at least some exposure in the four main investment geographies (North America; Europe; Asia; emerging markets) is usually a good way to take advantage of some of the opportunities arising in other parts of the world, as well as smooth out portfolio performance over time. Keep in mind that one way to do this is by investing a portion of your portfolio in well-known, blue-chip companies that operate internationally. Coca-Cola sells their soft drinks all over the world, for example. You’ll find iPhones on all continents. The same goes for Nike shoes and Volkswagen cars, as well as HSBC bank branches, just to name a few random examples. And, of course, region-specific mutual funds and exchange-traded funds (ETFs) offer easy, cost-effective “instant diversification” to all four corners of the world.

Problem: a few big winners are overwhelming your portfolio

File under “good problems to have”: after a long-running bull market, a handful of your positions have seen strong performance. So strong, in fact, that a few big winners have come to comprise a hefty percentage of your portfolio. Sure, you could hold on to them, hoping for further gains − but at this point in the bull run, would that be wise? You’re beginning to wonder about the growing concentration risk, as more and more of your portfolio is concentrated into a few names. Should a problem occur with any one of these, your portfolio could take a big hit.

Solution: trim positions and get back to your allocation targets

Yes, it’s true, some of the most successful investors in the world have become so by holding highly concentrated portfolios (once again, Warren Buffett is a famous example). But let’s be honest: by the time they become snowbirds, most people aren’t really investing in order to become filthy rich stock market billionaires. Rather, they want to ensure that they have enough to live a high quality of life for their remaining years, with as little uncertainty or volatility as possible.

After a strong bull run, it makes sense to trim back winning positions and bring your portfolio back in line with your normal diversification targets. Yes, taking some money off of the table might mean that you miss out on some gains. But, spreading your eggs among different markets, different assets and different management styles smooths out periods of volatility, and prevents one bad mistake from destroying your portfolio. That’s a trade-off which most snowbirds are willing to make.

Problem: you have a “kitchen sink” portfolio

The financial industry often focuses on new ideas, the latest trends, and fresh strategies that investors are only now hearing about. Nothing wrong with investing this way once in a while − indeed, some of the most successful investments that you’re likely to make will be responses to new technologies, new trends or new market events. But if that’s all that you’re doing, you could end up with a kind of “kitchen sink” portfolio − a collection of investments that cover a wide array of industries or trends, with different levels of risk and widely varying performance, without a lot of purpose or reason for any of them to be in the portfolio. Such portfolios make investment decisions exceptionally difficult: without knowing why a given investment is in the portfolio, or how you hope for it to bring you closer to your long-term goals, it’s difficult to assess your risk tolerance, evaluate portfolio performance, or even know when to buy or sell.

Solution: find the purpose for your positions

There’s nothing wrong with investing in a “hot stock” or a fresh investment trend as long as you’ve done your homework and you’re staying within your personal risk tolerance. But, when you look at your portfolio as a whole, you should be able to see a broad plan or purpose behind your holdings: how they position you for long-term growth; how they align with your risk tolerance; how they help you accomplish your financial and life goals; and so on. If you have a collection of investments that doesn’t really fit with any of those bigger-picture purposes, it might make sense to sell, or at least trim some of your “collection” and instead, give some thought to crafting a long-term financial plan that can provide some longer-term direction.

Problem: too many bets, long shots and “wild punts”

Are you an investor or are you a speculator? Are you investing in a quality business with the intention of long-term price appreciation (investing)? Or are you buying a risky asset in hopes of quickly selling it at a higher price (speculating)? If you’re an experienced investor with a strong stomach for risk, you can certainly make a lot of money on high-risk, high-return speculations. But, if there are too many of those high-risk “quick flips” in your portfolio, or if you find yourself gravitating more toward long-shot opportunities on which you could just as easily lose a fortune as make one, then that’s an attitude that’s more akin to gambling than investing.

Solution: focus on investing, not speculating

If you must speculate, make sure that you understand the rules of the game: it requires an inherently different mindset than long-term investing, and a lot more attention, too. You can make a lot of money, sure, but you could lose a lot, too − don’t ever fool yourself into thinking that this universal truth doesn’t apply to you.

You can minimize this risk by keeping your positions small, keeping your expectations reasonable and keeping your attention laser-focused on what’s going on with your positions. Speculations should comprise no more than what you could afford to lose completely − perhaps 5% of your overall portfolio at most. Make sure to do your research with every speculation, and seek out second (or third) opinions to check that research before you commit. Above all, be prepared to quickly exit positions that don’t work out and move with extreme caution − it’s often the “high-risk, high-reward” ideas that get punished first in any downturn.

Problem: too much safety

The opposite problem is also pretty common: investors who are so concerned about stock market volatility that they try to avoid it altogether. In extreme cases, these investors load up their portfolios with cash, low-yielding investments such as GICs, savings accounts and similar investments − earning little on their investments at all. As a result, the portfolio barely manages to keep up with the rising cost of living, much less make up for regular withdrawals. Given enough time, such an approach leaves the investor at considerable risk of running out of money entirely.

Solution: realize that you need some risk

It’s understandable that we would want to avoid risk as much as we can. But, in an age in which medical advances and healthier lifestyles mean that we’re living a lot longer, it’s time to realize that not taking on enough risk may be an equally dangerous problem. You can solve this problem by making sure that your portfolio always maintains a balance between “less risky” investments such as cash and GICs, and assets that are “more risky,” but offer performance that can actually keep up with the rising cost of living over time. For most snowbirds, this will mean keeping at least a portion of the portfolio allocated to well-managed, blue-chip, dividend-paying equities. Another alternative is to take a portion of your portfolio and purchase an annuity that guarantees you a certain base level of income for life − a particular benefit for those of us who don’t have a defined-benefit pension. This way, you’ll always have peace of mind knowing that a good portion of your wealth is unaffected by the ups and downs of the market.

Problem: not enough liquidity

Financial experts typically tell investors to take a long-term view of their portfolios and be prepared to hold their positions for several years before selling. That’s fine in theory. But, as anyone who’s lived for a few years knows, reality is often different. In real life, “stuff” happens – and, when it does, the solution usually involves money. And if you’re not able to access yours quickly, that could be a huge problem if a family member needs quick cash, or you have an unexpected hospital stay or medical expense, or your roof starts leaking at the first thunderstorm of the summer. That’s even more the case if a sizeable portion of your portfolio is in relatively illiquid investments: a rental property, for example, or locked-in investments such as GICs, or shares of an operating business.

Solution: hold some cash and cash equivalents

Should you sell your rental property or cash in all of your stocks just to ensure that you always have enough cash on hand? Of course not. But neither should you ignore the need for cash altogether. Instead of tying up your portfolio solely in long-term holdings, make sure to keep at least a portion in cash or short-term, near-cash investments. How much? Five per cent of your portfolio or six months’ worth of everyday expenses is probably a bare minimum. Feel free to adjust that number up or down, depending on your individual circumstances.

Problem: plenty of gains, not enough income

Maybe your portfolio is heavily invested in growth stocks that don’t issue dividends (high-tech stocks, for example). Maybe you’ve only recently retired, and you never really needed income from your portfolio before. Or, perhaps you’ve been reluctant to invest in bonds, GICs and other traditional income investments when interest rates are so darn low. Whatever the reason, your portfolio isn’t generating nearly enough income to meet your basic needs, which forces you to sell small portions of your holdings on a regular basis. Nothing wrong with that in a strong bull market − there are plenty of gains to go around. But what if we experience a market downturn? Selling into a downturn just to generate cash to pay your bills, take a vacation or live the good life would hardly be ideal.

Solution: start thinking about income

If you’re a snowbird who relies on your portfolio to support your lifestyle, it’s time to include some income investments in your portfolio, even if that means trimming back on some of your growth investments. That income can come from multiple sources: dividend-generating stocks, bonds and guaranteed investments, real estate and, of course, mutual funds and ETFs that hold such investments. And, as you advance in years, you should include more and more of these income-generating investments in your portfolio − a steady paycheque from your portfolio will help you avoid having to sell at inopportune times.

Problem: you’re not really clear about what to do

One of the challenges of a market in which everything seems rather expensive is that it’s sometimes tough to figure out exactly what to do. Add to that a lot of analysts, pundits, commentators and journalists who are all talking about how the stock market party is coming to an end − and an equal number who are all talking about how it isn’t. All too often, the result is a kind of “paralysis” in which you’re not entirely sure of what to do, so you end up doing nothing.

Solution: seek a professional opinion

Doing nothing is not always a bad thing in the investment world. But if you find yourself becoming increasingly reluctant to take any investment action, or hesitant to make any financial changes for fear of making the wrong decision, that can be a sign that it’s time to call in some help. While not everyone needs to work with a wealth advisor, financial planner, accountant, tax lawyer or other qualified financial professional, for those of us who need some guidance or advice about what to do (or what not to do), there’s probably no better solution.

No, not every financial decision needs to be discussed or debated with someone else before you make it. But, if you’re truly stuck, it makes a lot of sense to seek out a sounding board − someone who can give you some perspective about what’s going on, and who can help provide a course of action for helping you achieve your long-term goals. Sure, such guidance and oversight might cost you more than trying to muddle through and figure things out by yourself. But the feeling of actually moving toward a solution to your portfolio problems − rather than being stuck in the middle of them − for most people, that’s an investment worth paying for.

by James Dolan