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Course 301
How to Monitor Your Portfolio, Part 1

Introduction

Even in the most casual workplaces, managers review their staffers annually. And for good reason: Employers compensate employees for performing well, and employees need to know how well their supervisors think they're doing and whether they're on track to meet their career goals. Their livelihoods depend on it.

Your investment portfolio requires regular reviews, too. You need to supervise it, just as your manager supervises you, to make sure it stays on track.

The classes in the 300 level of Investing Classroom's Portfolio track will show you how to oversee your portfolio and modify it when necessary.

This course will cover monitoring procedures, as well as how to review:

  • The performance of your individual investments and your overall portfolio
  • The characteristics of your portfolio
  • The fundamentals of your mutual funds

Portfolio 302 will focus exclusively on how to review the fundamentals of your stocks.

Your Monitoring Procedures

Those of you who've created an Investment Policy Statement have already developed your monitoring procedures. In doing so, you answered the following:

  • What is my target allocation for each asset class (stocks, bonds, and cash)
  • How often will I monitor my portfolio?
  • How will I determine how well my investments are doing?
  • How will I determine how well my overall portfolio is doing?
  • Is my portfolio meeting my expected return?
  • What fundamental criteria will I focus on as I review my holdings?
  • How often will I rebalance?

If you haven't developed your monitoring procedures or created your Investment Policy Statement, review Portfolio 108 and download Morningstar's Investment Policy Statement Worksheet at http://news.morningstar.com/pdfs/Investment_Policy_Worksheet.pdf. (Note: The worksheet is available as a PDF file. You will need Adobe® Acrobat® Reader to view and print it.)

As you can see, tracking your portfolio means more than just monitoring its performance. It means keeping an eye on your portfolio's characteristics, too. And it requires you to make sure that the fundamentals of your individual investments haven't changed since you bought them.

Monitoring the Characteristics of Your Portfolio

The first step in the portfolio-monitoring process is to take a close look at your portfolio’s characteristics. Are there significant developments that merit your attention?

Portfolios aren't static. They change without us doing anything to them. That's because market forces will make some investments perform better than others--which means they'll take up more of our assets. Or fund managers buy and sell securities, and in doing so, they change underlying portfolios of your mutual funds and the look of your overall portfolio.

Ignore these changes and you may end up with a portfolio that's very different from the one you originally put together. Ignore these changes and you may be taking on more risk than you think. Finally, ignore these changes and you may not meet your goals.

Look for unexpected changes in your portfolio. If you find some, you need to determine how significant these changes are and if they in any way threaten your long-term investment plan or your portfolio's short-term volatility characteristics.

Investors can enter their portfolios in the easy-to-use Instant X-Ray tool, or they can use Morningstar.com's Portfolio Manager to monitor their portfolios' characteristics via the Portfolio X-Ray tab for more comprehensive analysis. Either way, you'll get an X-ray of your portfolio holdings combined together. You'll find out how your portfolio looks from a series of key vantage points.

Asset Allocation

How does this current asset allocation compare to the original asset mix that you established for yourself? If the mix is off-base, it may be time to rebalance. We cover rebalancing inPortfolio 305.

Style Box Diversification

How does this style mix compare with your original mix? If things differ dramatically, you might consider rebalancing here, too.

Stock Sector

What segments of the stock market is your portfolio most and least exposed to? Is this what you expected? And how does it compare with your original sector mix?

Stock Type

You may find that you have a lot of investments that are of the same stock type or in the same stages of their life cycles. That isn't a bad thing, per se. But having too many aggressive and speculative growth investments can lead to lots of volatility.

World Regions

How diverse are your investments around the globe today, and how do these figures compare with the global mix you set up for yourself originally?

Stocks Stats

Is your portfolio carrying a high price/earnings ratio, making it more vulnerable to price risk than it may have been when you initially invested?

Top-10 Holdings

How much of your assets are in each of your investments? Is this amount significantly different that it was last time you checked in? If so, you may need to rebalance.

Monitoring the Fundamentals of Your Mutual Funds

Just as you watch for unexpected changes in your portfolio, watch for changes in your mutual funds, too. You want your funds to meet the same investment criteria today as they did when you first bought them. You set out your investment criteria in your Investment Policy Statement, and you should hold your mutual funds to those criteria. If they no longer meet your criteria, do they still belong in your portfolio?

Just because a fund no longer meets one or two of your criteria is no reason to sell. But if a fund no longer clears most of your hurdles, it is a sell candidate.

For example, perhaps you purchased a fund five years ago to fill a small-growth role in your portfolio.

If today, however, the fund lands squarely in the mid-cap growth slot of the style box, you're investing in a fundamentally different fund than you once were. 

Many financial Web sites, such as Morningstar.com, offer alerts to investors signaling key changes to holdings. Morningstar.com's alerts inform investors when, say, a mutual fund changes star ratings, or moves into a new style-box position.

Monitoring Performance

Once you’ve reviewed your portfolio’s characteristics and those of individual fund holdings, examine its overall results during whatever time period you’ve chosen. (The longer the better! Short-term performance trends are often little more than noise.) How do these returns compare with the benchmark you've established for this portfolio and the long-term returns you're expecting?

Of course, your portfolio isn't going to return exactly what you need each and every time you examine it; the idea is for the portfolio to average out to that expected return figure over time. So if your portfolio has not met your average required return over whatever time period you've chosen, don't panic. Conversely, if your portfolio has returned more than you expected, don't go on a spending spree.

However, if your portfolio has suffered losses, make sure those losses are within the acceptable range you set forth in your Investment Policy Statement. If not, your portfolio may have more risk in it than you think, and you may need to re-evaluate your holdings.

Let's take an example. Say you own shares of Vanguard Total Stock Market (VTSMX), Vanguard Total Bond Market (VBMFX), T. Rowe Price High-Yield Bond (PRHYX), and T. Rowe Price Emerging Markets Bond (PREMX).

To understand why your portfolio behaved as it did, turn to your individual holdings. For example, In Morningstar.com's Portfolio Manager, you can see your gain and loss in a stock or fund since you initially purchased it.

Maybe one or two of your investments fell short of expectations while others returned more than you expected--understand why. Perhaps stocks were in favor during the period, so your equity holdings did better than your bonds. Put the performance of your investments in context.

The best way to do that is to compare your returns with those of an appropriate benchmark--the benchmark you laid out for each investment in your Investment Policy Statement. By clicking on the Views tab, you can create a custom view that shows the data points of your choice—in this case, each fund’s three- and five-year returns as well as how those returns stack up to its category peers.

For more about benchmarks, take a look at Funds 202: How to Benchmark Fund Returns.

   
 

Quiz 301
There is only one correct answer to each question.

  1 What should you do if your portfolio's returns fall short of your expected performance over a short period of time?
    a. Panic. You're relying on this portfolio to return a certain amount each and every year.
    b. Do nothing. It'll bounce back.
    c. Don't panic, but do find out why your portfolio isn't meeting expectations--especially if your portfolio is suffering losses that are beyond your acceptable range.
  2 The best way to put an investment's performance into context is to compare its returns to those of:
    a. Other investments in your portfolio
    b. An appropriate benchmark
    c. The overall return of your portfolio
  3 Portfolios:
    a. Change when we do something to them
    b. Can change when we do nothing to them
    c. Both A and B
  4 What can happen if you ignore changes that occur in your portfolio?
    a. You may be taking on more risk than you think.
    b. You may not meet your investment goals.
    c. Both A and B
  5 What should you expect from your mutual funds as you're monitoring them?
    a. That they're still meeting your investment criteria
    b. That they're outperforming all other funds
    c. That they're outperforming their benchmarks over every possible time period, no matter how short term
To take the quiz and win credits toward Morningstar Rewards go to
the quiz page.
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