Don't throw laggard holdings out

You don't want your portfolio moving in lockstep because when some of your holdings are lagging behind then others are outperforming.

Ashley Redmond 22 July, 2014 | 5:00PM Adam Zoll
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Ashley Redmond: I'm Ashley Redmond for 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: So, Adam when our portfolios are doing really well—we're talking strong gains in the past few years and stock and bond holdings that are through the roof—we tend to take comfort in that, it feels satisfying. What's the problem with that?

Zoll: Well the problem is that it may feel good right now. But if all of your investments are sort of performing in lockstep with one another, it may actually be a sign that you are not properly diversified. Ideally, the purpose of diversification within a portfolio is that things are not all moving in the same direction at the same time. When some of your holdings are lagging behind then others are outperforming and then when those outperformers start to cool down the laggards start to heat up. So, if you're finding that everything is moving in lockstep that may actually be a red flag.

Redmond: Our Director of Personal Finance Christine Benz talks about the rearview mirror trap. So what is that?

Zoll: The rearview mirror trap is basically getting caught up in recent performance, especially strong performance from some of your holdings. It may be tempting to say, boy, this fund that I own has really been going gangbusters, so I'm going to add more assets to that. The problem is that the fund that is going gangbusters today may cool down tomorrow and by the same token a fund that is not doing so well today, may start to heat up and do well. We have a metric here at Morningstar called investor returns. Investor returns are based on asset flows into and out of funds and they show that more volatile funds especially those all over the map—well investors don't use them particularly well.

Oftentimes investors pile into these funds when they are doing really well only to find that they turn and start to head south, whereas investors tend to use more stable funds better. The point is that the recent strong performance of a fund is by no means an indication that that’s going to continue. You need to really watch the long-term track record of the fund to get a better idea of how you should respond.

Redmond: And the investor return data point is something that you use on and we're actually getting it on soon, so stay tuned for that. And now with the rearview mirror trap is that something that only unsophisticated investors get tied up in?

Zoll: Well even experienced investors can fall victim to this. It’s part of knowing yourself as an investor whether you are more subject to falling prey to that kind of a trap. But even experienced investors need to look within their portfolios to see why certain holdings are doing well. For example, a large cap fund that is outperforming its peers over a specific time period, maybe doing so because it also has a small stake in small-cap stocks, which are performing even better.

So if you are looking at the recent performance of the large-cap fund and it looks really rosy, but then small-caps take a turn south, then that fund may actually be an under performer over the next time period.

Redmond: Sometimes as investors when we hear this we just think, maybe we should just go contrarian. So should we do that and what's the problem with that?

Zoll: It may be tempting to say everything is going this way I'm going to go the other direction to make sort of drastic reallocation decisions. That could be a real mistake. You have no way of knowing when the market may turn, when today's hot performer is going to head in a different direction. What you are better off doing is sort of paring back on those strong performers and maybe funneling those assets into a category or an asset class that has been underperforming. Be prudent about it, don’t go whole hog and make a drastic reallocation decision.

Redmond: Thanks so much Adam.

Zoll: My pleasure.

Redmond: For more personal finance insight check the personal finance section at

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Ashley Redmond

Ashley Redmond  Ashley Redmond is a Vancouver-based freelance writer.

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