X-raying your asset allocation

Published 2:58 pm Friday, August 27, 2010

Having been urged to ensure that the assets in your portfolio are allocated and broadly diversified in accordance with your financial goals, your investment horizon and your risk tolerance level, you have made all the necessary adjustments.

Before you relax in the aura of your accomplishment, however, you may want to check your holdings in detail, just to be doubly sure you actually own what you think you own.

You can do this by putting your holdings through an X-ray. Just as your dentist can scan an X-ray and spot potential problems, an X-ray of your portfolio allows you to look under the covers. You’ll gain a better understanding of what you own and can make adjustments, if necessary, on the basis of what’s actually there rather than making assumptions because of general names and descriptions.

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Individual mutual funds, for example, have been known to gradually stray away from their initial missions—so much so in some cases that the name of the fund may no longer be a true guide to its character. Your mid-cap fund, you could be surprised to learn, perhaps holds far more small-cap or large-cap stocks than you had imagined.

In addition, an X-ray can tell you what sectors you’re exposed to, the regions of the world in which you’re invested and the stock styles that characterize your portfolio—that is, how it stacks up as to its large-cap, mid-cap and small-cap holdings, as well as whether they are by nature growth, blend or value holdings.

Portfolio character

Putting your portfolio under an X-ray can give you a thorough understanding of its various components. You can then zero in on its strengths and weaknesses and make assessments likely to be far more accurate than if you merely acted on the strength of general names or labels.

What are the real percentages of cash, U.S. stocks and bonds, foreign stocks and bonds, alternative investments, and real estate contained within your portfolio?

Only with a comprehensive understanding of those true ratios can you compare your intended asset allocation with what your portfolio actually contains.

With your portfolio dissected, you can better understand how the various elements relate to and affect one another. You may discover that your portfolio is far more focused on growth than you had intended, because, say, your particular mutual funds—other than the clearly growth-focused ones—happen to also contain large growth elements you hadn’t considered. A quick glance may not show you that anything is out of line with your intentions—a detailed look under the hood may reveal otherwise.

As you look at the details of your portfolio, match up your intended allocation to the actual components revealed. Do your foreign holdings line up with your expectations? Is your small-cap exposure uncomfortably larger than you had thought?

As you check over the nuts and bolts of your portfolio, you’ll be deciding whether you’re comfortable with how its components are put together.

Spur to action

It can be fascinating to see a detailed scan of your portfolio (or, similarly, of specific mutual fund holdings). Savvy investors use an X-ray as a guide to possible action. After comparing the details of what you learn with your expectations from your portfolio—or perhaps your 401(k)—you can work to bring it into the balance you had originally determined. When you do, you’ll be acting on the strength of basic facts rather than the sometimes erroneous impressions that linger from mutual fund names.

If you would like to discuss taking a closer look at your portfolio as a way of checking up on your asset allocation, just give me a call.

Investors should carefully consider the investment objectives, risks, charges and expenses of mutual funds before investing. The prospectus contains this and other information about mutual funds. The prospectus is available from your financial adviser and should be read carefully before investing.

Investing in small-cap and mid-cap stocks generally involves greater risks, so an investment in these stocks may not be appropriate for everyone. Asset allocation does not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss.

International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise.