The end of the year is almost here! You probably can't wait until 2020 is over, but there is one final investment action you must take before you change the calendar.
Performing a year-end portfolio review will let you see how well your investments have done and set your portfolio up for success in the next year. Here are five critical things you should make sure you're including in your review.
1. Review your asset allocation
Your asset-allocation model in its simplest form is your combination of stocks, bonds, and cash. Your mix is probably broader than this, though. At your portfolio review, you can do a deep dive and see just how much. What portion of your portfolio is made up of small-cap stocks versus large-cap stocks? Growth stocks versus value stocks? Investment-grade bonds versus high-yield bonds?
Each of these asset classes has performed differently this year, and your allocations in them will change as a result. For example, by mid-October, large-cap growth stocks were up 24.33%, but large-cap value stocks were down 11.58%. Asset classes that performed well will make up a larger portion of your account, and ones that performed poorly will make up less. This is important because each of these subsectors carries a different level of risk. If you have a heavier weighting in a riskier category, you may have more volatile performance than you want even if your broader allocations don't change by much.
2. Reassess your comfort with risk
2020 has been a rocky year. The S&P 500 started off the year at 3,258. Fears surrounding COVID-19 caused the markets to correct, and by March 23 it reached a low of 2,237 -- a loss of more than 31%. As of Nov. 24, the S&P 500 has completely rebounded and is trading at record highs of 3,635 -- 3,577.72 -- nearly 12% higher than where it started at the beginning of the year.
If you found weathering these ups and downs difficult, you should reevaluate your risk tolerance. Do you feel more uncomfortable with volatility than you did before? Did you start off in too aggressive of an asset-allocation model and only realized it when the markets corrected? You can reassess your comfort level with risk by taking a questionnaire that will take into account important things like your time horizon and your reactions to the markets. It will also factor in life events that would change your ability for taking risks, like the loss of a job.
3. Evaluate your rate of return
How did your assets perform over the last 12 months? Your investment account may already calculate the rate of return that you've earned. If not, you can calculate your own weighted average return by figuring out how much each asset class you own has earned relative to the percentage that it makes up of your overall account. For example, if you own a 50% stock and 50% bond portfolio, and stocks are up 10% while bonds are up 2%, your weighted return is (.5 x 10%) + (.5 x 2%) = 6%.
Next, you'll want to find a good benchmark that you can use as comparison, like the average rate of return for your asset-allocation model. When evaluating performance, you should always compare apples to apples. If you have a conservative portfolio made up of mostly bonds and are comparing it with the S&P 500, your expectations may not be properly set. You should also factor in any withdrawals, additions, and purchases or sales of investments that might have impacted your overall return.
4. Rebalance your portfolio
As the markets shift, so will your asset allocations. Because stocks are positive year to date, your stock holdings are probably a greater percentage than they started at the beginning of the year. If the markets experience a pullback in 2021 and your accounts are more aggressive than they should be, you could experience larger losses than if you rebalance back to your initial allocations.
You can rebalance your portfolio allocations every year at the same time no matter how much they've changed. Or you can also use your review as a check-in period and only rebalance if they've moved more than five or 10 percentage points from your targets.
5. Check your beneficiaries
Your beneficiaries are the people that will inherit your money in the event that you die. As you experience important life events like getting married or having a child, you should update your beneficiaries, but it's common that this very important portfolio update gets neglected.
You can make sure this doesn't happen by making it a part of your portfolio review process. By default, your retirement accounts will let you name a beneficiary. You also may have the option of naming beneficiaries on your nonretirement accounts and can find out how by checking with your financial institution.
A year-end portfolio review is a vital step in the investment planning process. Properly setting up your accounts is important, but it's just as critical that you maintain them. Making a portfolio review a part of your annual plan will not only help you make sure that you are on track for meeting your goals but also ensure that your objectives are still in line with the way your accounts are invested.