Around this time every year, “well-used” shirts magically disappear from my closet. For years, I thought I was losing my mind. Then I realized that it was my wife’s not-so-subtle way of telling me it was time to do a little spring cleaning.
She’s right. It was time to throw away the moth-eaten T-shirts with mustard stains. But had she not taken the initiative (or had she actually informed me of what she was doing), they would still be cluttering up my closet.
Spring is a good time to clean out your house and take your old junk down to the curb. But it’s also a fine time for a little portfolio spring cleaning. Tax season has just ended, so you’re more likely to have household finances on your mind.
It’s smart to use this time wisely, take the initiative and do a little house cleaning on your investments. After all, due to the compounding effects of returns, small changes today can make a big difference years or even decades down the line.
So today, let’s look at five tips for pruning your portfolio:
Portfolio Pruning Tip #1: Take Stock of What You Have
Before you prune your portfolio, you need to figure out what’s in it. And if your finances are anything like mine, they can be cumbersome to keep track of.
I have three IRA accounts that I can’t combine for various reasons, two current 401k plans, an HSA investment account and a smattering of brokerage accounts and private partnerships. And that’s just me. My wife also has two retirement accounts, and we have four assorted college savings plans for our two kids.
So the first step here is simply to remember what you have and either find a recent statement or dig up your login details.
A good financial planning application like Mint.com or Personal Capital can be helpful here. But if you’re concerned about internet security or just want to keep it simple, an Excel spreadsheet — or even pad of paper and a pencil — will get the job done just fine.
This isn’t rocket science and doesn’t have to be overly elegant. It just needs to be functional.
Portfolio Pruning Tip #2: Ask Yourself “Why Did I Buy This?”
Justifying a stock purchase can sometimes seem a little like justifying teenage hijinks: “It seemed like a good idea at the time!”
But if you can’t remember why you bought a stock, then there is a real possibility that it no longer deserves a place in your portfolio.
Opportunity costs are real. You can’t measure loss just as a decline in the value of stock you own. You also have to consider the money you could have made had you bought something else. Thus, a dead-weight stock you bought years ago for reasons that are now lost to history can do real damage to your long-term returns.
Before you worry about portfolio allocation, asset classes or any of the other things that financial planners focus on, do an initial sweep of all of your accounts. Look at every position one by one, whether it be a stock, an exchange-traded fund, a mutual fund or anything else under the sun. Ask yourself why you bought it … and more importantly, if you would buy it today if you didn’t already own it.
But be honest with yourself. It’s possible you had very good reasons for buying the stock a few years ago, and those reasons might still be perfectly valid. But then … they might not be.
As a practical example, I would pay particular attention to any technology stocks or stocks that were trendy a few years ago. Maybe you got wrapped up in the hype. (It happens to us all once in a while.) But just make sure you’re being honest with yourself.
If you wouldn’t buy it today with new money, you probably shouldn’t continue holding it.
Portfolio Pruning Tip #3: Take a Look at Valuations
Bear markets create truly strange pricing. For a time in early February, boring consumer staple Clorox Co (CLX) actually had a higher forward price-to-earnings ratio than highflying tech darling Facebook Inc (FB).
Nothing against Clorox, of course — it’s a fine company and has been around forever. But a slow-growth staple like that is not likely to keep pace with the broad market starting at these prices. So, as part of your portfolio pruning, consider selling or at least lightening the load on any stocks you have that seem to be priced a little aggressively.
Remember: A great company can be a lousy stock if it’s overpriced … and you don’t want it weighing down your portfolio. So again, ask yourself, “Would I buy this stock today, at today’s prices, with new money?” If you can’t answer that question with an enthusiastic yes, you should probably sell and move on.
The one caveat here is to watch out for taxable gains. If you own the stock in a taxable account, you have to consider the tax effects of selling. If selling would generate a large tax bill, you might want to spread out the selling over more than one tax year or try to offset the gains with losses elsewhere.
Portfolio Pruning Tip #4: Make the Best of Tax Loss Harvesting
OK, so you’ve done that initial sweep and gotten rid of the stocks that no longer make sense or that are overpriced. Well done.
Now, let’s talk taxes.
I hate losing money. But I’m a big believer in making lemonade out of lemons. If you have stocks, funds or ETFs in your portfolio with losses — even if they are investments you intended to hold on to for a while — consider selling at least part of them to offset any capital gains you might have. You can always buy the stock back in 30 days or buy a substantially similar stock immediately.
That last part might need a little explaining. Let’s say you bought the SPDR S&P 500 ETF Trust (SPY) at the top and you’re sitting on losses. If you sold it to take the tax loss, you wouldn’t be able to buy it back for 30 days. But you could immediately use your proceeds to buy the iShares S&P 500 Index (ETF) (IVV), which is for all intents and purposes the same thing.
Again, I hate losing money, and I would never use tax loss harvesting as an excuse for sloppy investing. But losses are going to happen from time to time, and when they do, you ought to use them to your advantage.
Portfolio Pruning Tip #5: Give Your Asset Allocation a Second Look
What applies to stocks can apply to entire asset classes.
You might have had a really good reason for owning, say, a bond fund in your 401k plan. But depending on when you made that purchase, bond yields might have been a lot higher. Maybe it makes sense to shift those funds into something with shorter maturity or something more tactical in nature.
Also, your asset allocation should change as your age and stage of life change. The allocation you put together at 40, when you were first entering the prime years of your career, might be very different from the allocation you want at 60, nearing retirement.
Even if you end up not making any major changes, spring is a good time to make an assessment. You already have your beginning-of-the-year priorities like funding your IRA out of the way, so the second quarter is a nice time for a little portfolio pruning.
Check out our full checklist if you haven’t already, or tab back over to the checklist to see other ways you can clean up your portfolio.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.