Less to Fear With Well-Diversified Portfolio

Posted: Apr 18, 2009 12:01 AM
Less to Fear With Well-Diversified Portfolio

Q: I've lost $800,000 of my formerly $2.6 million portfolio and it's killing me. I'm really uncomfortable having my money, everything I have ever earned, in a place where I really don't know what is happening or why. My husband and I want to retire in about 10 years and we recently bought some new property, and it all feels like it's slipping away. How do I stay the course?

A: First, let's turn those dollars into percentages. You've lost 30 percent. And while that feels frightening to you, losing 30 percent in 2008 suggests that your portfolio could be well diversified. If so, you probably don't have as much to worry about as you think.

Without knowing where your money is invested and relying solely on the 2008 performance you've described, you should consider staying the course. But let me elaborate on what that really means. People sometimes accuse me of being someone who argues for the "buy and hold" approach, and that is not what I'm saying. My argument is that you should "buy and rebalance."

In other words, if you have a properly diversified portfolio, the key is not to simply hold on to it, but to rebalance it. Compare your portfolio's allocation of one year ago to your portfolio today -- and rebalance it so that today's portfolio looks like last year's portfolio.

That would be a positive step because it enables you to sell assets that are relatively high in value (selling high is always good) and buy assets that are lower in value (and buying low is always good). If your financial planner hasn't been doing that for you, you need to ask why.

Q: I have a 30-year fixed mortgage at an interest rate of 5.75 percent and I was wondering when it would make sense for me to refinance. How low would interest rates have to go?

A: Twenty years ago, I would have told you that interest rates had to drop 2 percent in order for refinancing to make sense. That rule is no longer true because the cost of refinancing is much lower these days, as are interest rates.

I suggest you call your mortgage company and ask, "If I were to refinance, what would be the new interest rate and what would be my new monthly payment?" Then ask how much it will cost to get that new loan.

If it costs $1,000 to refinance and doing so saves you $50 per month, it will take you 20 months to break even. If you're going to move during or soon after that time, it's not worth it. But if you plan to stay in the house 10 years, it's a good deal.

By learning the costs and savings of refinancing, you can decide if it's worth it.

Q: I have a question on an exchange-traded fund. I'm basically a buy-and-hold investor in retail mutual funds. But as you know, panicky selling hurts existing shareholders. Are ETFs less likely to see portfolio disruption by shareholder redemption? Why?

A: Yes, they are less likely to suffer, for three reasons: One, they tend not to attract market timers to the same extent that retail mutual funds do, so there is less likelihood of trading in that regard; two, they have very low turnover themselves, which means they are not as likely to be subject to style drift or bracket creep because some fund manager is trading heavily; three, due to the way many ETFs handle their tax reporting, they are able to offset one investor's selling with another's buying -- enabling the fund to avoid reporting the transactions as capital gains or losses.

This explains why the typical exchange-traded fund often issues capital gains distributions that are dramatically lower than those offered by typical retail mutual funds.