Do your holdings pass the decluttering test?
Asking how well your holdings are doing their jobs is a starting point for trimming your portfolio.
A few years back, an unlikely book shot to the top of the best-seller lists. It was a book about clutter--or rather, getting rid of it.
Marie Kondo's The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organising was a runaway hit, and Kondo became a celebrity not just in her native Japan but in the United States, too. A companion series featuring Kondo launched on Netflix, and her philosophy spawned a nation of declutterers. Like Kondo, these tidy-home enthusiasts noted that getting organized and making do with less stuff helped them think clearly and freed them up to focus on what's really important.
It's hard to argue with that, and many of those same virtues can be extended to decluttering a portfolio. With fewer moving parts to oversee, it's easier to focus on the truly important aspects of your portfolio plan. Are you on track to reach your goals, whether a comfortable retirement or a home down payment? Is your asset allocation sane, given your life stage?
And like decluttering your home, reducing the number of odds and ends in your portfolio has the salutary effect of making life easier for those who have to manage your affairs when you can no longer do it yourself.
Put your holdings to the test
Of course, decluttering is more art than science, whether you're getting rid of stuff in your coat closet or your portfolio.
Kondo's criterion is that each possession you hang on to must "spark joy," which is a bit squishy. I can't say that the down parkas in my coat closet spark any sort of joy in my heart, especially in July. But they are necessary for Chicago winters.
Perhaps more straightforward and practical is the test that home declutterers have long been advised to employ when deciding what to keep and what to toss: Is it useful? Is it beautiful? An item gets bonus points if it's both, but it goes into the pile for Goodwill if it's neither. The parkas? Not beautiful, but useful. They stay.
In a similar vein, portfolio declutterers can put each of their portfolio holdings to a straightforward test. Beauty isn't a consideration with investments, but usefulness certainly is. Thus, it's reasonable to assess your holdings' utility value. Have they delivered on key investment goals, whether growth, income, or stability? Or better yet, have they delivered on more than one of these goals?
Armed with an assessment of how well your holdings have performed the jobs you hired them to do, you can then start to determine what to keep and what to give the heave-ho. Of course, there may be mitigating factors--a holding in your portfolio may not have done much for you lately, but you like its bottom-up attributes. But the simple "jobs" test can help you determine which holdings merit further scrutiny and possibly dismissal from your portfolio.
Getting the job done
To get started with decluttering your own portfolio, start by tagging each of your holdings with your goal (or goals) for them. What basic investment functions do you expect them to fulfill?
In my view, there are three main goals that investments can serve: growth, income, and stability. (Investments may also help to diversify a total portfolio--and, thus, improve that portfolio's risk/reward profile--but you'd hope that they would also deliver at least some growth, income, or stability along the way.)
Most investors look to their holdings to provide more than one of these basic attributes. For example, you might hold dividend-paying equities for a combination of current income and growth, as well as to be less volatile than your other equity holdings. You own bonds, meanwhile, to help lend stability to your portfolio; you probably also look to them to provide income.
Once you've articulated what you're expecting your holdings to do, you can then size up how well they've delivered. Morningstar.com's Analyst Reports and performance data can be a big help on this front. However, narrow peer groups can make it easy to get lost in the weeds, and short-term performance can be noisy. Here are some simple tests for determining how well your holdings have done their jobs over long periods of time.
Growth: If you're holding an investment for its long-term growth potential, it's reasonable to use the long-term performance of a total-market equity index fund when benchmarking how well it has delivered. Total U.S. market index funds have returned about 17% during the past five years and 15% during the past 10.
Equity holdings shouldn't automatically go on the chopping block if they don't beat those simple benchmarks. It could be that they look absolutely nothing like those benchmarks, or the trailing time periods cast them in a bad light yet they've earned their keep in other environments. But you'll want to make sure they've delivered on another goal--either income, stability, or diversification--to merit a continuing slot in your portfolio.
Income: If you're holding equities at least in part for their income production, a payout that's higher than the S&P 500's--currently just about 1.2%--is a reasonable (and surprisingly competitive) starting point. Good-quality dividend-yield-oriented funds have yields of about 2.5% currently.
Setting an income hurdle is trickier for bond investments, as a bond fund's yield will tend to be inversely related to how much stability it provides. You may be able to find a yield north of 2% or even 3% from a fund that delves into lower-quality or otherwise higher-risk bond funds, but you'll sacrifice on the stability front. If you're aiming for a fund that balances yield with stability, you'll have to settle for substantially less. As a benchmark, funds that track the Bloomberg Barclays U.S. Aggregate Bond Index currently yield about 1.3%. Those are low numbers, of course, but you'll likely see improvement on this front when interest rates begin to head up. More important, bond funds play a valuable role in helping to stabilize equities.
Stability: If you're holding an investment to stabilise the more-risky portions of your portfolio, you can go straight to a simple gut check. How did it do in 2008? If you're holding bonds to stabilize your total portfolio, you'll want to see small losses--or even gains--in that year. Equities, of course, lost substantially more than that in 2008. But if you're holding equities because you expect them to hold up better than the broad stock market in a downturn, it's reasonable to look for losses of less (preferably much less) than 30%.
Standard deviation is another way to gauge an investment's stability (or lack thereof). For bond holdings, a 10-year standard deviation of 3.5 or lower is a reasonable threshold for assessing stability. Lower-risk equity funds, meanwhile, have posted 10-year standard deviations of less than 14. That's not to say you shouldn't hold investments whose volatility levels exceed those thresholds, but rather that stability shouldn't be a key reason for owning them.