The Better Inve...'s  Instablog

Thanksgiving Day is over and for at least a few days our thoughts will turn to ways to get some of those extra calories out of our systems – a brisk run, perhaps, or a couple extra hours at the gym. It may also be a good time to do some “calorie counting” for our portfolios. Here are five tips for trimming some excess pounds from our investments:

1.  Compare fee structures

Remember that every percentage point a fund manager earns is a percentage point of return that you lose. So it really matters if you are paying 1.5% for a fund where the peer universe average is 1% or less. The right comparison to make is to consider exposures by distinguishable asset class. See how the fee structures of the funds you hold in each of those asset classes measure up to averages or medians for their respective peer universes. This is important because average fees in a class like emerging markets are most likely higher than those in core fixed income, for example. Fees are not the only attribute that matters in fund selection, of course, but you should always make sure you are not paying more than you reasonably need to.

2.  Consider your active / passive asset mix

Most of us are not rigid ideologues in the active versus passive debate. That is to say, we accept that our portfolios can allow an appropriate role for both active and passive vehicles. The point here is to look more closely at where active strategies may really be worthwhile, as opposed to where they seem to do little more than mimic the benchmark. One very useful metric for this purpose is R-squared, a correlation measure that shows how closely a fund tracks the performance of its benchmark. For active funds, an R-squared measure of 0.75 – 0.85 is appealing. It indicates that the fund stays largely within the strategy represented by the benchmark, but at the same time is not afraid to deviate from the benchmark in search of opportunities for outperformance. An R-squared of 0.95 or higher, on the other hand, would signal a higher likelihood that the fund is doing little more than just tracking the benchmark, which an ETF could do just as well and most likely be much cheaper.

3.  Look out for duplicate exposures

It sometimes happens that we take on an exposure thinking that it will serve one purpose when it turns out to do little more than duplicate the performance of another portfolio category. Here is an example of what I mean. A portfolio that I recently evaluated consisted of a variety of equities asset classes and an allocation to alternative assets. A fund within the alternative category was billed as a “go anywhere” absolute return fund. The purpose of this fund was to invest across a range of things – stocks, commodities, currencies, short positions, etc. – such that it would produce reliable returns regardless of the general direction of stocks or bonds. The problem was that, in reality, the fund was doing no such thing. It was investing almost entirely in large cap US stocks, such that it was virtually indistinguishable from the funds in the portfolio’s equities category. In other words, it was not living up to its billing and was a wasted exposure for the portfolio investor.

4.  Take advantage of tax efficiency opportunities

I am a big believer in the idea that taxes play a supporting role in investment decisions, rather than driving those decisions. Still, there are often opportunities to trim a little fat through smart tax planning. For anyone who can benefit from realizing tax losses, tax loss harvesting is one good exercise to undertake as the year draws to a close. It is also a good idea to periodically check your funds to see if they are tax efficient relative to their strategies. Things like high turnover (frequent buying and selling of fund holdings) and dividend distributions trigger tax events. For some funds, these activities are a necessary part of their strategy. But in other cases, they can be excessive.

5.  Maintain a rebalancing discipline

One of the most important ways to keep your portfolio in shape is to stick to a rebalancing discipline. Rebalancing should occur at a minimum of one time per year. This is when you sell assets whose value has increased and buy those whose value has decreased in order to bring your portfolio back to its target asset class weightings. These weightings are important for long term portfolio success. Implement a rebalancing calendar and stick to it. Many investors choose to do their rebalancing at the end of the year or beginning of the next year. Timing is simply a matter of personal preference, but maintaining the discipline year in and year out is one of the most important things you can do to reliably achieve your financial objectives.