Portfolio Analysis: An Adventurous $496,000 Investment Plan
All investment portfolios are comparable to a novel, where each individual chooses their own personal genre and classification. If your investment portfolio were a novel, what genre would it be: adventure, comedy, drama, mystery or horror?
My latest portfolio report card is for M.D. in Temecula, California, and he has an adventurous portfolio. He's also 61 years old, married and semi-retired. He self-manages his $496,000 retirement accounts and works for a transportation company.
M.D.'s investment portfolio consists of a traditional individual retirement account and Roth IRA. His $496,000 nest egg is spread across seven different Vanguard mutual funds, and around $8,000 is invested in his Roth IRA, while the rest is in his traditional IRA. He told me "growth is my main goal" and "my money will be used as an income source over the next few years."
What kind portfolio report card grade does M.D.'s retirement plan get? A, B, C, D or F? Let's analyze and grade his investments together.
Traditional IRA | Dollar value | Asset class | Expense ratio |
|---|---|---|---|
Vanguard Capital Opportunity Fund Shares | $47,635 | U.S. large cap (growth) | 0.48% |
Vanguard Dividend Growth Fund Investor Shares | $109,235 | U.S. large cap (dividend) | 0.31% |
Vanguard Equity-Income Fund Investor Shares | $45,430 | U.S. large cap (value) | 0.30% |
Vanguard Health Care Fund Admiral Shares | $184,626 | U.S. stocks (health care) | 0.30% |
Vanguard Long-Term Bond Index Fund Investor Shares | $43,312 | U.S. long-term bonds | 0.20% |
Vanguard REIT Index Fund Admiral Shares | $57,925 | U.S. real estate | 0.10% |
Vanguard Health Care Fund Investor Shares | $8,040 | U.S. stocks (health care) | 0.35% |
Total value | $496,203 |
Cost. Reducing investment costs should be every prudent investor's priority. And of course, investment portfolios with excessive trading activity or elevated fund expenses are major red flags. But so are portfolios with hidden 12b-1 fees, loads, and advisory fees that don't commiserate with the actual advisory work being done.
M.D.'s portfolio consists of seven Vanguard mutual funds with annual expenses between 0.10 percent and 0.48 percent. In addition to contained fund expenses, he has little trading activity, so his portfolio grades well on cost.
Diversification. Investment portfolios that lack exposure to all of the major asset classes, including stocks, bonds, commodities, real estate and cash, are not truly diversified. It's an irrefutable truth.
M.D.'s self-managed retirement accounts have exposure to U.S. stocks, U.S. bonds and U.S. real estate. That's good, but he still misses major categories, such as international and emerging market stocks, international real estate, commodities and cash. Additionally, his portfolio has overlapping exposure in U.S. large-cap dividends and large-cap value, which creates unnecessary clutter.
Risk. M.D. describes himself as an aggressive investor, yet his current asset mix of 91 percent stocks and 9 percent exposure to bonds is more than that -- it's hyperaggressive. Almost 40 percent of his investments are concentrated in health care stocks alone, through Vanguard Health Care Fund Admiral Shares.
Overall, I estimate that a 20 percent to 40 percent stock market correction will expose M.D. to potential losses between $90,000 and $180,000. That's more heat than he can probably handle.
Tax efficiency. All well-built investment portfolios deliberately minimize the negative impact of taxes. That means smart tax location, such as putting tax-inefficient assets like bonds and REITs into tax-deferred accounts. Stock funds can generally be kept in taxable accounts.
M.D.'s retirement plan did not have any observable problems with tax efficiency.
Performance. The correct standard of performance isn't distorted peer groups, which are common in the mutual fund industry, but rather how a person's portfolio performs relative to a blended mix of passive index exchange-traded funds that correspond to the person's asset allocation.
M.D.'s one-year performance was a 36 percent gain, compared to a 15.22 percent gain for a blended benchmark that matches his asset allocation. What were the main reasons for M.D.'s sizzling returns? The answer is he concentrated almost 40 percent of his portfolio in health care stocks through the Vanguard Health Care Fund Admiral Shares.
The final grade. M.D.'s final portfolio report card is a "B." His portfolio graded well on minimizing cost. It's a tax-efficient portfolio and his performance beat a blended benchmark.
Although "B" is a good overall grade, it's not perfect and M.D.'s portfolio flunks on diversification and risk. His asset mix of 91 percent exposure to stocks is hyperaggressive, even for a 61-year old "aggressive" investor. His portfolio also completely misses exposure to key asset classes, such as international and emerging market stocks, global real estate, commodities and cash.
A 20 percent to 40 percent market correction potentially exposes M.D.'s portfolio to very large losses. The good news is this can be alleviated by adjusting his overall asset mix, and earmarking a portion of his money toward less volatility.
Although M.D.'s current portfolio could be classified as "adventurous," he's probably reached a point in his life that requires a lot less adventure.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. He's inventor of the Portfolio Report Card which helps people to identify the strengths and weaknesses of their investment account, IRA, and 401(k) plan.
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