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What's The Cost of Inactivity?
April 24, 2011
Bradley R. Newman, CFP®

There are many ways a portfolio can be mismanaged. While most investors are familiar with 'churning', which occurs when a broker makes unnecessary trades to boost their commissions or simply to show that some activity is taking place in the portfolio, over the past several years it is likely that more damage has been caused by the complete lack of action in the face of changing market conditions or evolving client needs.

While the recent spate of geo-political unrest in the Mid-East and natural disaster(s) in Japan has made it both more difficult and more important to diligently manage your portfolio, it has also made it even more critical to continue to protect yourself from the inevitable downside risks that have become consistent fixtures in the investment world. As you turn a critical eye toward managing your portfolio, the real question becomes: "Is anybody really managing my portfolio?"

Downside Protection Is Critical

Successful investing is less about capturing 100% of the market's upside and more about missing the potholes.

The broad impact to your portfolio from a Bear Market, such as the 'Tech Bubble' or the recent financial crisis, will be more detrimental than the impact of missing some of the upside of a Bull Market. This is especially true the closer you are to retirement.

Being over-exposed to a particular sector that falls out of favor, Hardware/Software in 2000 or Financials in 2008, can also be devastating.

Additionally, being over-concentrated in a particular holding can be equally disastrous; for example some locally based holdings that, if not appropriately reduced as their stock prices began to fall, likely derailed more than a few portfolios include Rite Aid, Allied Irish Bank and Tyco.

What Is Your Advisor's Responsibility?

Understanding the relationship you have with your advisor is critical. Are you in a brokerage relationship where you will receive suggestions or ideas, but the ultimate decisions are up to you; or, are you in a relationship where your advisor is actively managing your account and will proactively make changes within an agreed upon set of parameters.

If you have a management relationship with your advisor, it is imperative to determine whether you are actually getting the active portfolio management that you are paying for; don't assume that you are.

Doesn't Management Benefit Everyone?

Regardless of the type of relationship that you have with your advisor, everyone should benefit from the diligent management of your portfolio.

If you utilize a broker, the commissioned broker benefits by generating more commissions when they make trades in your account to implement the necessary portfolio changes.

If you utilize a for fee investment manager, the typical fee for portfolio management is based on a percentage of assets that are managed; i.e., the larger the account grows, the larger their fee.

The question that is difficult to answer is; "If all advisors benefit financially from actively managing their client's investment portfolios, then why are there so many advisors who do nothing?" The unfortunate reality is that even during the worst of the 2008 - 2009 financial crisis many people were simply told to 'ride it out' and no changes were made to their portfolios.

Prudent Management Remains Critical

Let me stress that trading for trading sake is unproductive and trading to simply generate broker commissions borders on malpractice; however, not prudently making allocation changes and security selection changes as the markets and a client's needs evolve is indefensible and is often more detrimental than making a few unnecessary transactions.

Bradley R. Newman, CFP from Roof Advisory Group, Inc., an independent investment management and financial advisory firm based in Harrisburg. The firm is a fee-only Registered Investment Advisor that provides portfolio management and financial planning services for individual and institutional clientele. The firm's email address is invest@roofadvisory.com.

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