Complacency is a threat to portfolios

Ashley Redmond: I'm Ashley Redmond from Morningstar.ca, and I'm here with Adam Zoll, a member of our personal finance team.

Adam, thanks so much for joining me.

Adam Zoll: My pleasure.

Redmond: There are a lot of threats to our portfolio things like instability in the Middle East or a potential stoppage of growth in the U.S. economy, a lot of things that we really don't have control over. But our Director of Personal Finance, Christine Benz, says the biggest threat to our portfolio is actually something that we do have control over and it’s complacency.

Zoll: Right. Well, lately the market has been performing very strongly. Both stocks and bonds have been pretty strong performers since the financial crisis, so it is easy to get complacent. We look at our portfolios from time to time and the number keeps growing. So, it's easy to sort of sit back and say, this is great, I'm enjoying this, and I’m a wonderful investor. But, at the same time complacency is a danger because the markets are not going to go up forever. Eventually there will be a turn and they will start heading south. If you leave your assets to grow sort of organically within the market then it's very easy for those assets to fall out of your target allocation. So you really need to keep an eye on that and make sure that you are staying on target.

Redmond: So, is it possible to protect your portfolio without shutting off its potential return?

Zoll: By all means, it is possible. You don't want to make dramatic defensive moves and go 100% defensive. For example, you certainly wouldn't sell your entire retirement portfolio and put it all in cash or anything that dramatic. But you might want to make some reallocation decisions based on parts of your portfolio that perform very strongly. Possibly channel some of those assets into some of the underperformers and really get back to that target allocation. If you're not exactly sure what your target allocation should be, maybe look at the allocations used in a target-date fund. That can help you find your true north in terms of where you should be.

Redmond: So, Christine Benz says, checking sub-allocations is a good idea and I think you agree with that?

Zoll: Yes, I do. In fact, I think that sub-allocation decisions can be just as important as the broader allocation decisions, stocks versus bonds. What's happening within those stock and bonds can also really have a dramatic effect on your portfolio.

As an example, an investor who had a well-balanced portfolio five years ago coming out of the financial crisis as the bull market was starting, probably is going to be overweight on stocks right now. And even within stocks, for example, developed market stocks have performed particularly well; emerging markets not so much.

Making sure you check on those sub-allocations, bringing those back into balance with regard to what your target balance is equally as important as looking at just the stock versus bond picture.

Redmond: Okay. And next up, Christine suggests checking liquid reserves. So, again, why is that such a good idea?

Zoll: So, first of all, if you're a retiree living on those liquid reserves you want to make sure that you have at least one to two years of cash or cash-like investments for your own income needs. But also in a market like today when stocks are at least fairly valued, maybe a little overvalued in the estimation of our Morningstar equity analysts; bonds, there is interest rate risk, there is fear that bonds may start to take a downward turn here soon. You may want to hold a little bit more cash than normal, so that you can opportunistically dollar cost average back into the market if those asset classes start to take a turn downward.

Redmond: And lastly, Christine suggests guarding against overconfidence. And that really relates back to our overall theme of complacency.

Zoll: Right. It reminds me a little bit of the dotcom bubble. You may remember, when tech stocks were going through the roof everybody felt like they were a brilliant investor because you almost couldn't go wrong. Anything with dotcom attached to it that you invested in performed great. Well, we all know how that turned out. And I'm not saying that we're in anything like the dotcom bubble now, but there is that danger that people in this strong bull market that we've seen—one of the longest bull markets in history—that people will become overconfident. They feel like they don't need to keep close tabs on their investments, or basically just expect that the market is going to continue to go up. But history tells us that's just not going to happen. We really need to keep an eye on our holdings.

Redmond: So, overconfidence is something we also need to be aware of?

Zoll: Exactly.

Redmond: All right. Thanks so much, Adam.

Zoll: My pleasure.

Redmond: For more personal finance insight, go to the Personal Finance section of Morningstar.ca.