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4 Critical Changes To Make To Your Portfolio Before It's Too Late

Tuesday, March 25, 2014 10:00 AM

Investors tend to give their portfolio half of the attention it needs.

They add stocks and funds to the mix, presumably making a commitment in dollar value that is commensurate with the perceived risk of any investment. But once an asset makes it into their portfolio, they don't always actively monitor how the investment is faring -- or how it fits in with the changing economy. Years may pass before you take a fresh, deep look at what you really own. I have met many investors who own a hundred stocks or more, simply because they could never know when to sell any particular investment.

Here's a simple, four-step method to make sure your portfolio is in fighting shape.

1. Focus On Weightings
It's often wise to let your winners ride, especially if the news that propelled shares higher continues to flow.

But your best portfolio picks can eventually start to account for an outsize portion of your portfolio. There's no great rule of thumb about how much is too much, but generally speaking, any one holding that has come to represent 15% or 20% of your portfolio needs very close scrutiny. Unless you have done an extra amount of research that gives you high confidence that this investment is poised for more gains, it's time to start trimming back. Selling half of the position would likely bring it back in line with other holdings, on a relative weighting basis.

In fact, it's wise to periodically calculate the relative weight of all your portfolio holdings, which sets a clear picture for step two.

2. Too Much Industry Concentration?
Once you have calculated the weight of each holding, you should then group them together by industry and sector.

Often times, a particular industry will hold great appeal in terms of value or growth, and investors may take stakes in several key players. But if more than 25% of your portfolio ends up being directed toward just one sector or industry, then it is carrying too much risk. Focus on the best investments in the group, and look to sell any holdings that provide redundant exposure.

In a similar vein, you should also identify the beta of each of your investments (which you can find on Yahoo Finance, Morningstar and other key websites). Although stocks with a high beta have performed especially well in the past five years, there is no reason to think high-beta stocks will continue to lead the pack. Remember: A high beta also signals high risk.

An ideal portfolio has a beta between 1.0 and 1.5. So if you are off the charts with this metric, then you can either sell your holdings that have the highest beta, or add stocks and fund to the mix that have a beta below 1.0 (Typically, defensive stocks such as utilities and other industries that are characterized by slow and steady growth.)

You can calculate your portfolio's beta by identifying each investment's beta, and then multiple it by the weight it has in the portfolio (i.e. an investment that is 15% of the portfolio would have its beta multiplied by 0.15). Then add up the whole set of them to get a total beta for the portfolio.

3. Take A Fresh Look At Your Losers
An investments that slumps in value often stays put in a portfolio. Investors figure that "this stock was once worth more, and it will be worth that much again...someday." Yet that's not the way to view these lagging holdings.

Instead, look at every stock in your portfolio through the prism of "would I buy this stock right now with fresh funds if I didn't own it already?" If the answer is no, then there is really no good reason to keep holding it, unless there are tax-related implications. Unloading the dead weight not only frees up cash, but provides a psychological boost as you are now only focusing on your best ideas, and not forced to look at your investing mistakes on a daily basis.

4. Pairing The Macro And The Micro
Once a year, Wall Street analysts and financial media outlets try to provide a fresh look at the investment landscape for the year ahead. It's a useful exercise, though it need not be done only at the start of the year: A broad mid-year assessment is also helpful.

Such assessments help us to see where pockets of strength in the domestic and global economies are emerging, and where pockets of weakness are also emerging. By taking the pulse of economic trends, you can then be sure that the macro backdrop is well-represented by your portfolio holdings.

To be sure, it's OK to have some contrarian representation. For example, retailers are seeing weak sales these days, but many best-in-class retail stocks represent such solid value that it's OK to buy and hold them until retail prospects improve. The key is not to be too contrarian with your portfolio positioning.

Risk to Consider: The five-year bull market has been remarkable for its consistent rewards. Growth stocks, such as the leading dot-coms, have surged in value year after year. Yet in the next few years, other sectors and asset classes may assume leadership, so it's wise to have exposure to all corners of the market.

Action to Take --> Actively reconfiguring your portfolio's orientation too frequently may lead to a spike in transaction fees and capital gains and losses realizations. So it's best to trim your portfolio at the margin, like a hedge in your garden. Pruning the outliers is the prudent approach.

P.S. Are you terrible at knowing when to sell? You're not the only one. Fortunately, a former trust fund manager created a two-part blueprint that reveals when to sell... and when to buy. It's been 85% accurate for over four years -- and just closed out a 70% gain. Click here to access it now.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.