Overview – Combating an Underperforming Investment Portfolio
Any serious investor will care about how their portfolios are doing, whether they admit it or not. After all, a portfolio that performs well is necessary to ensure an investor reaches their goals in a timely manner.
However, it would be naive to think that every portfolio always has an upward trajectory. Sometimes, things don’t go as expected and a portfolio’s performance starts to deteriorate.
Now, a portfolio that starts to show signs of deteriorating performance isn’t the end of the world. However, a continuous, downward trend isn’t something that can be ignored forever – neglect this problem for too long and an investor may soon find themselves dealing with an even larger headache.
An underperforming investment portfolio will sometimes be an issue for investors, but thankfully that doesn’t mean they’re completely powerless. There are some things they can do to reverse course.
Taking the Time to Assess Current Portfolio Performance
Before reaching the conclusion that your portfolio isn’t performing as well as you’d hoped, the first step is to understand how exactly your portfolio is currently performing. This may sound like an obvious first step to take, but many investors are quick to jump to conclusions without first checking the current state of their portfolio.
No competent doctor would diagnose you with a terminal illness without first performing a series of tests and/or potentially referring you to a specialist. Although a misdiagnosis sounds like a relatively minor problem, in the U.S. alone medical misdiagnosis is a serious problem that’s estimated to cost the American economy up to $750 billion every year.
Similarly, no competent investor would declare that they have an underperforming investment portfolio without first checking if that’s truly the case. Acting prematurely on a problem that doesn’t exist in the first place may cost an investor dearly.
Thankfully, we’ve talked about the different ways to measure portfolio performance before. Different metrics such as percent gain/loss, trailing returns, and CAGR will help give you a better idea of current portfolio health.
While assessing the performance of your entire portfolio is important, it’s also important to take the time to assess individual holdings. It’s possible for your portfolio to be doing well, but for this performance to be the product of just a handful of strong investments, while the rest are doing very poorly.
Not only that but understanding the performance of your individual holdings is critical information you’ll need to know if you do in fact need to turn things around (more on this later).
After thoroughly assessing your portfolio’s current performance, it may turn out that you’re simply panicking and that there’s no real reason to worry. Spending time, effort, and energy trying to turn around a portfolio that doesn’t need to will ultimately prove to be a huge waste – no sensible investor wants that to happen.
Knowing the Difference Between an Underperforming Investment Portfolio and Volatility
Before an investor embarks on trying to improve their portfolio’s performance, it’s very important to remember that there’s a difference between a portfolio that is indeed suffering from poor performance and one that’s simply being affected by volatility.
When it comes to volatility, it’s never a matter of if it will appear, but rather, when it will inevitably show up. The worst part about volatility is that it can affect virtually any investor, regardless of how robust their portfolio is.
Volatility is akin to the tide, and the portfolios of different investors can be thought of as the different boats docked in shore. Some boats are very big, while others are more modest. However, when the tide comes in, every boat rises. When the tide recedes, every boat is lowered. The size of your boat doesn’t matter – the tide affects all boats regardless.
No investor can predict when volatility will appear, or how bad it will be, but there’s one truth about it that never changes – it’s temporary. No matter how bad volatility gets, it’s only a matter of time before this short-term frenzy subsides and investment markets are corrected as logic and rationality start to return.
On the other hand, suffering from poor performance is a long-term problem that slowly eats away at your portfolio.
If volatility is akin to the tide that comes and goes every day, then poor performance can be thought of as a hole on the side of a boat, which allows water to slowly but surely enter, gradually sinking it in the process. It may take a while for the boat to sink, but if the hole isn’t dealt with then it’s only a matter of time before the boat is completely underwater.
A decline in portfolio performance is a problem that takes a long time to develop before it becomes clearly noticeable. This is why when assessing portfolio performance, it’s best to do so over the longest period possible: by doing so, the effects of volatility are smoothed out, leaving you with a better picture of how your portfolio is doing based on the decisions you made and the strategies you implemented.
So, if you decide to assess your portfolio and discover that your portfolio’s value has declined over the past 12 months, then this is most likely just the product of volatility. But, if you notice that your portfolio has lost a significant chunk of value over the past 5 years, then perhaps it’s time to dig deeper.
Some Ways to Turn Around an Underperforming Investment Portfolio
After determining that you do in fact have an underperforming investment portfolio on your hands, there are a few actions you can take to help turn things around.
It’s important to note that there’s no action that will guarantee an improvement in performance. Rather, the best that an investor can hope for is that the actions they take greatly improve the chances that their portfolio will recover. Remember, there are many external factors beyond an investor’s control that have the potential to affect them, no matter what they do.
There are myriad actions an investor can take to improve performance, but the ones we will be going over are relatively simple and can be done without spending too much time and energy. Let’s go over some of them.
Sell Individual Investments That Are Underperforming
The first logical step would be to let go of holdings that are weighing your portfolio down. Remember, investment merit changes all the time – if a certain investment operation has lost its merit, then there’s no reason for you to keep it in your portfolio any longer.
Again, it’s important to differentiate between sustained, poor performance and volatility. The last thing you want to do is to part ways with a solid investment that’s suffering from the effects of volatility, not poor business fundamentals.
Assuming you routinely assess your holdings every time new data is released, such as the release of quarterly or annual reports, then these underperforming investments shouldn’t be too difficult to detect over a long enough time period.
Some investors dream of holding on to certain investments forever, but circumstances change all the time. Investments that made sense to own yesterday may prove to be a liability today. When faced with this sort of situation, the sooner you part ways with an underperforming investment operation, the better.
Increase Your Stake in Investments That Are Doing Well
After letting go of investments that aren’t pulling their weight, the next logical step would be to increase your stake in investments that are doing well.
It’s often said that, if you want to improve, you should first work on dealing with your weaknesses, which is true – in this context, that could mean selling bad investments or adding better investments into the fold.
However, while it’s important to work on your weaknesses, it’s just as important to capitalize on your strengths: in this scenario, that means earmarking more capital to investments that are clearly keeping your portfolio afloat.
A handful of outstanding investments will contribute more to your portfolio than dozens of mediocre ones. Outstanding investment opportunities are hard to come by, but when you do come across them and are lucky enough to purchase them at a price you believe is fair, then your portfolio will benefit greatly.
If outstanding investments have such a profound impact on your portfolio, then it would make sense to make sure they contribute more to your portfolio’s composition.
Check That Your Returns Aren’t Being Diluted (i.e., Consider Concentrating Your Portfolio)
Portfolio concentration vs. portfolio diversification is a topic that has been discussed, analyzed, and studied for decades. Naturally, we’ve talked about this topic before, where we looked at the pros and cons of each approach.
While both approaches have their fair share of strengths and drawbacks, when it comes to diversification there’s one fact that’s very hard to dispute: spreading your capital across too many investments has the potential to adversely impact your returns. This is because not enough capital is dedicated to a single investment such that it has a large enough impact on your portfolio, for better or for worse.
In a perfect world, an investor would have no shortage of capital to work with, so they’d be able to make hundreds of very large investments, simultaneously maximizing gains while also minimizing investment risk. However, no investor has infinite capital to work with, so this approach is impossible.
We will not re-ignite the concentration vs. diversification debate in this article, but if you find yourself dealing with an underperforming investment portfolio and you happen to have lots of relatively small holdings, then perhaps it’s time to consolidate your capital to just a handful of solid investments, as opposed to spreading it out across several mediocre ones.
You can own several outstanding investments, but that won’t matter if you only allocate small sums of capital to them. These investments could experience very strong growth in the future, but this growth won’t make much of an impact if they make up only a small portion of your portfolio.
Wrapping Up
Every investor dreams of having a flourishing portfolio, but circumstances change all the time, and sometimes this can lead to a decline in a portfolio’s performance. An underperforming investment portfolio is a problem that some investors may one day find themselves dealing with.
Before acting, it’s important to understand the difference between a portfolio that truly is declining, and one that’s simply being affected by short-term volatility. Because of this, the first step to take before trying to turn a portfolio around is to have a clear understanding of current performance, both for the portfolio as a whole and individual holdings.
If an investor does find themselves dealing with a lackluster portfolio, then they can rest easy knowing that they have many options to turn things around. These options don’t even have to be overly complicated: sell underperforming investments, increase stakes in strong ones, and consolidate your investments, to name a few.
Although an investor has the ability to turn their portfolio around through their actions, there’s no guarantee that what they do will result in better performance. The actions they take will certainly improve their odds, but there are still countless variables beyond an investor’s control that can ultimately affect them, for better or for worse.
