Portfolio analysis is the process by which an existing portfolio’s asset allocation is reviewed to determine whether the current allocation achieves the investor’s short- and long-term financial goals without taking unnecessary risks related to the capital invested.
To perform a proper portfolio analysis, we assess a person’s risk tolerance, personal income level, age range and investing time horizon to develop a portfolio mix, between equities, fixed income and cash, to provide the highest possible probability of achieving their desired long-term rate of return while minimizing short-term financial risks.
Why is portfolio analysis important?
Long-term investment returns are always determined by the types of assets held in an investor’s portfolio. As such, the investor must balance their portfolio goals with their risk tolerance. Although every investor would ideally prefer to own growth-oriented assets to offset the long-term risk of inflation, the short-term risks of enduring market volatility and uncertainty often counteract the rewards of growth – many investors cannot bear the cyclical ups and downs of the stock market. Even further, those investors with a shortened time horizon – such as those nearing retirement – cannot afford to endure a market downturn.
Common misconception about what constitutes a portfolio
We have seen time and time again where investors split their assets between financial advisors and financial institutions, only to have each separate portfolio “balanced” according to each financial advisor’s own interpretation of the investor’s risk tolerance, and only sometimes with respect to their financial goals. In fact, an investor’s financial goals are often not adequately contemplated in such situations because of this fragmented approach.
An investor’s portfolio consists of all the investable assets with a view to the investor’s risk tolerance and financial goals. That means that all assets must be considered – registered assets in retirement accounts, TFSAs, open cash and margin accounts, cash in banks, real property holdings, investments held within insurance contracts or universal life insurance policies, other collectible assets such as art or coin collections, and private business assets and holdings.
Assets held through these different investments often have drastically different tax attributes. For example, all growth within registered retirement accounts is tax-deferred, but all distributions are fully taxable upon receipt. That means that it is arguable that growth-oriented assets that produce capital gains, which are only subject to a 50% income inclusion, should likely not be included in your RRSP portfolio because you will lose the tax advantages afforded to the 50% non-taxable portion of the capital gains when you receive those amounts as fully taxable retirement income. Conversely, assets that produce interest income, which is fully taxable, should likely not form part of your unregistered investments as they will be fully taxed at your personal marginal tax rate thereby decreasing the amount of re-investable assets (net of tax).
Dividends, which receive some preferential tax treatment, may or may not fit within a registered or unregistered portfolio. The problem is that in practice, due to the division of assets between advisors and financial institutions, each portion of an investor’s portfolio is balanced separately. So, often what an investor sees is one, or more, RRSP accounts that are balanced between equities, fixed income and cash and one, or more, unregistered accounts balanced between equities, fixed income and cash, and so on.
Very few portfolios are balanced globally for the investor. For example, it is entirely possible that 100% of an investor’s RRSP could be invested in tax inefficient fixed income assets which would represent the portion of the global portfolio that is dedicated to fixed income. Then the open accounts may contain all tax efficient growth equities which represent the portion of an investor’s global portfolio dedicated to equities, and so on.
There are obviously other complicating factors such as availability of investable assets. Depending on the stage in one’s life it is entirely possible that the only investable assets are owned in a registered retirement account, or vice versa, in an open cash account thereby limiting these strategies. But, over time, with a proper financial plan combined with proper portfolio analysis, an investor can achieve all of their financial goals in the most tax efficient manner possible thereby reducing their lifetime taxes paid by tens of thousands of dollars or more.
Short and long-term financial goals
An investor can have multiple financial goals at the same time, both short-term and long-term. For example, an investor may be cognizant of saving for retirement (long-term) but may also have a financial goal of saving for a car or a down payment on a house (short-term).
These goals can be achieved by creating two separate portfolios with drastically different risk and investment profiles. Once a short-term financial goal is achieved the resources that were devoted to that goal may then be available for another short-term goal or for use with achieving the long-term goals.
Use a professional
As you can see, portfolio analysis is not static and requires numerous iterations within one’s lifetime.
The analysis of a portfolio is best conducted by a professional who has the knowledge and expertise to properly evaluate all the different variables that affect the long-term performance of different asset classes and that considers the different types of short- and long-term risk.
It is only by measuring an investor’s short- and long-term goals against various investment possibilities and return probabilities, that a professional advisor can provide valuable advice to an investor in determining one, or more, proper portfolio mixes best suited to meet their unique situation.
At SPARK, we utilize the tools and expertise of our product providers to assist us to best meet an investor’s needs, both short- and long-term. We, at SPARK, also recognize our limitations and defer to the professionals to determine proper asset allocation based on our extensive review with our clients. We act as quarterback in gathering all information, processing and summarizing it, and then providing it to the professionals to propose a suitable solution (investment mix) for our clients.
What is needed to start the process for portfolio analysis?
It is usually recommended that we start the process by meeting with you and:
- assessing the family dynamics (i.e. spouse, children, ex-spouse);
- assessing the employment situation (i.e. employee, future income potential, job stability, self-employed, incorporated, partnership, time to retirement, and retirement income sources);
- assessing the current financial situation (i.e. net worth and determining available cash flow);
- assessing existing assets and creating a global picture (i.e. registered accounts, TFSAs, open accounts, cash in banks, real property holdings including principal residence, investments held within insurance contracts or policies, other collectibles and private business assets and holdings); and
- assessing the client’s financial goals, both short- and long-term
Once we have gathered all this information we can work with our product providers and request that they offer their best solution to suit your needs. Once we have obtained several options we will meet with you again to review those options and determine a strategy to effectively and efficiently re-position your assets, and/or allocate excess cash flow, to achieving all your financial goals.
Other considerations/final thoughts
Your portfolio analysis should always be reviewed after any major life event – such as a birth, death, or divorce – to ensure it reflects your new reality, and then adjust it as necessary.
Products and services used in portfolio analysis
- Registered retirement accounts – RRSPs, RRIFs, LIFs, LIRAs
- Other registered accounts – RESPs, RDSPs, TFSAs
- Unregistered open or margin investment accounts
- Mutual funds within registered and unregistered accounts
- Segregated funds (effectively mutual funds offered through insurance contracts by life insurance companies that provide certain death and/or maturity guarantees)
- Investment or RRSP loans