There are plenty of reasons to make changes to your portfolio; some are good reasons, and some are not. Here are four good reasons to make a change:
More diversification. Diversification lowers the risk of your portfolio without lowering its expected return. That’s why it’s often called “the only free lunch in investing.” Here are a few ways to order off the free menu:
- If you invest in individual stocks, switch to a broad stock market index fund.
- If you only invest in US stocks, add international stocks.
- If you only invest in stocks, add bonds.
Lower costs. If you own expensive mutual funds charging an expense ratio of 0.5% or higher, you can save a ton of money by choosing cheaper funds. If your 401(k) only offers expensive funds, lobby for better investment options. Lowering your stock allocation—that is, putting a smaller share of your money in stocks and more in bonds—isn’t an admission of defeat; it’s a step on the path to success.
Simplify. If you have too many overlapping funds or a bunch of leftover 401(k)s from previous jobs, it’s worth consolidating down to as few accounts and as few funds as you can. People with complicated portfolios tend to lose track of what they own and why. You’ll probably end up more diversified and with lower costs by simplifying, too.
Get tax-efficient. Tax-efficiency is probably the most incomprehensible topic in investing.
Here are a few bad reasons:
A friend gave you a tip. Professional investment analysts go blind staring at computers 60 hours a week to find the best investments. Does your friend really know more than they do?
You heard something scary in the news. Thanks to the internet, you can find terrifying and seemingly actionable financial news 24-7. Unfortunately, you can find a bullish or bearish expert for any type of asset, and most of them are not much better than a Ouija board at predicting the future.
Any time you consider making a change to your portfolio, ask yourself: am I doing this to get more diversified, lower costs, bring my portfolio in line with my risk tolerance, get tax-efficient, or simplify my holdings? Or am I trying to predict the best or worst investment of 2012, something no one can successfully do until 2013? If it is within the latter group of answers, re-read this article!