Yahoo Finance Portfolio Analysis: A High-Risk $1.4 Million Retirement Plan
Barring an unexpected meltdown, it looks like the U.S. stock market will record its fifth consecutive yearly gain. Moreover, the Standard & Poor's 500 index will have gained nine out of the past 10 years. To say stocks have performed favorably would be an understatement. But why are so many investment portfolios still underperforming major benchmarks?
Think about it. If a portfolio cannot perform well during a favorable market climate, is it reasonable to expect outperformance when the stock market finally begins its way overdue correction?
My latest portfolio report card is for M.R. in San Francisco. He's 56 years old, married and works as an accountant. He asked me to analyze and grade his $1.4 million retirement plan. His plan consists of a $269,000 individual retirement account and 401(k) plan with $1,142,000.
His self-managed portfolio consists of 16 mutual funds and four exchange-traded funds. Does it pass or fail? Let's analyze M.R.'s $1.4 million retirement plan in five key areas, before I assign his portfolio a final grade of A, B, C, D or F.
M.R.'s IRA | Dollar Value | Asset Class | Expense Ratio | |
|---|---|---|---|---|
Dodge & Cox International Stock Fund | DODFX | $49,309 | International stocks | 0.52% |
DRIEHAUS Emerging Markets | DREGX | $21,557 | Emerging market stocks | 1.64% |
Fidelity Blue Chip Growth | FBGRX | $53,453 | U.S. large cap | 0.80% |
Fidelity Cash Reserves | FDRXX | $1,280 | Cash | |
Fidelity Select Gold | FSAGX | $1,466 | Gold mining stocks | 0.91% |
iShares Russell 2000 ETF | IWM | $17,221 | U.S. small cap | 0.20% |
PIMCO Real Return Class D | PRRDX | $40,984 | Bonds | 0.85% |
PowerShares QQQ Trust Series 1 | QQQ | $4,780 | U.S. large cap | 0.20% |
RYDEX ETF Trust Guggenheim S&P | RSP | $19,916 | U.S. large cap | 0.40% |
Third Avenue Real Estate Value | TAREX | $37,569 | U.S. real estate | 1.08% |
SPDR RUSSELL 3000 ETF | THRK | $3,927 | U.S. broad stocks | 0.10% |
AMG Yacktman Fund Service Class | YACKX | $18,152 | U.S. large cap | 0.74% |
Subtotal | $269,613 | |||
Vanguard Target Retirement 2025 | VTTVX | $363,725 | Multi-asset class | 0.17% |
AllianzGI NFI Dividend Value | NFJEX | $135,712 | U.S. large value | 0.70% |
T. Rowe Price Blue Chip Growth | TRBCX | $138,618 | U.S. large cap | 0.74% |
Royce Penn Mutual Investment | PENNX | 141,055 | U.S. small cap | 0.92% |
Vanguard Mid Cap Index | VMCIX | $139,158 | U.S. stocks | 0.08% |
Vanguard Developed Markets | VTMNX | $79,082 | Emerging market stocks | 0.07% |
PIMCO Real Return | PRRIX | $134,367 | Bonds | 0.45% |
Schwab Value Advantage MM | SNAXX | $11,157 | Cash | 0.21% |
Subtotal | $1,142,843 | |||
Total Value | $1,412,456 |
Cost. Smartly built portfolios always minimize investment costs, such as brokerage commissions and fund fees, which erode performance over time.
Around $771,490, or 54 percent of M.R.'s total account value, is invested in funds with elevated expenses. Of that amount, almost $550,000 in his 401(k) plan is parked in funds with expense ratios between 0.45 percent and 0.92 percent. The remaining $222,490 is in funds with expense ratios between 0.74 percent and 1.64 percent.
Although M.R. owns a few low-cost funds and ETFs, he doesn't make them a large enough part of his investments for his portfolio to grade well on cost.
Diversification. Many people, even certain financial advisors, have the misinformed view that a portfolio with 60 percent invested in stocks and 40 percent invested in bonds is fully diversified. In reality, authentic diversification is all about having broad exposure to all of the major asset classes, including not just stocks and bonds, but commodities, real estate and cash.
M.R.'s combined portfolios have exposure to international and U.S. stocks, bonds, U.S. real estate and cash. Unfortunately, M.R.'s portfolio suffers from overdiversification to areas such as U.S. large-cap stocks (he owns seven funds touching this same area). Also, all funds, excluding Vanguard Developed Markets Index Fund, Vanguard Mid-Cap Index Fund, Rydex S&P Equal Weight ETF, SPDR Russell 3000 ETF and iShares Russell 2000 Index ETF, are unacceptable diversified proxies of the asset classes where they invest, because they engage in style drift, securities concentration, or an attempt to beat a benchmark, versus representing it.
Risk. Investment portfolios that are incompatible with a person's risk capacity continue to be a major problem. M.R. described himself to me as a "growth investor." Does his portfolio harmonize with that description?
M.R.'s combined retirement plan asset mix is 84 percent stocks, 12.5 percent bonds, 2.5 percent real estate and 1 percent cash. Based on my analysis, M.R.'s asset mix goes well beyond the scope of "aggressive growth" for a 56-year-old investor, and is more appropriately defined as "hyperaggressive." A 20 percent to 40 percent correction in stocks exposes this portfolio to approximately $235,000 to $474,000 in market losses. Can he handle that type of heat?
Just because some of us can afford to take on greater financial risk, doesn't necessarily mean we should. And although it may work well during a raging bull market, there are side effects of taking big risks.
Tax efficiency. M.R. has no premature distributions from his retirement plans or 401(k) loans which could pose a tax threat to his money if he suddenly leaves his current job. M.R.'s retirement plan does well on tax efficiency.
Performance. M.R.'s annualized one-year gain was 8 percent, compared to a 10.64 percent performance return for a blended benchmark that matches up with his asset mix. Although M.R.'s underperformance may not seem like a lot, it's still unsatisfactory, especially during a favorable market climate like right now.
The final grade. M.R.'s final portfolio report card is a "C." M.R. is an outstanding saver and his portfolio's biggest strength is tax efficiency.
However, the portfolio's weakest areas are diversification and performance. Additionally, there is significant room for fund expense and cost reductions, and the risk of this portfolio, with 84 percent exposure to equities, is high.
Finally, a correction in the stock market exposes M.R.'s combined portfolios to substantial market losses. A grade of C indicates this portfolio has significant structural problems. M.R. is an outstanding saver. And if he fixes some of his retirement plan's weaknesses, I'm confident he can become an equally great investor.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. He's inventor of the Portfolio Report Card which helps people to identify the strengths and weaknesses of their investment account, IRA, and 401(k) plan.
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