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After the local markets saw returns of almost zero in 2016, anyone with a portfolio that ended the year in the green beat the market and can be chuffed with this result. But to achieve market-beating returns we need to focus on the process of managing our stocks within a portfolio because over time one often sees a portfolio drifting away from what one originally had in mind.
Optimising your ETFs
The first step is to check how much is invested into exchange-traded funds (ETFs) versus single stocks.
I recommended a portfolio with a minimum of 50% in ETFs. This figure can be adjusted to 100% if you’re just starting out. We protect our portfolio from ourselves via ETFs as the biggest risk to a diverse portfolio is the investor buying rotten stocks and hanging on. Also, remember your tax-free savings account – put the ETFs in there until the first R30 000 is invested every year.
The problem with ETFs is that if you’re not careful, you could end up holding a mixed bundle of random ones. How often over the last few years did you buy an ETF on a whim? Either because it was new and shiny, or somebody was punting it hard, or maybe just because suddenly Japan seemed exciting so you bought the Japanese ETF? Then, after a few years, you end up with a collection of random ETFs that is preventing you from following a clear investment strategy.
I did a clean-out of my ETF portfolio last year as I had suffered from this exact problem – I had a number of small positions in ETFs that served no purpose.
A simple diverse ETF portfolio just needs three ETFs: CSEW40*, DBXWD* and PTXTEN*. This gives you diversification across sectors, assets and currencies/geographies. If you want to reduce risk, you can add some bond or cash ETFs into the mix. But adding several others is not likely to improve returns and suggests a lack of strategy.
Kick the dogs out
When the ETFs are cleaned up, you move on to the individual stocks. Here I want around 10 to 12 stocks and they must be the best of the best, something I have often written about.
But first I want to deal with those dogs lurking in your portfolio. At some point every portfolio contains a dog or two that needs to be swiftly dealt with. It could be a stock you bought (usually a small cap) on some hot idea or tip with the expectation that it would soar higher in double-quick time but instead it slowly collapsed into a heap.
Another way dogs manage to creep into our portfolios is in the form of fallen stocks – these would be stocks that were once high-flyers but that just lost their way. This may be due to changing conditions in their market, new competition or perhaps the company just failed to evolve.
No matter how these dogs got into your portfolio, they need to go. How do you know they’re there? They are easy to recognise because of the way they make you feel every time you log into your portfolio – by that sinking feeling that settles in your gut. You made a mistake and you know it, but find yourself unable to do anything except hope that things will improve one day. But they never do.
So just sell that underperformer, even if the brokerage fee is higher than the value of the shares – it’ll never make you money and is clouding your thinking with painful memories. So, sell it. Sell it right now, I’ll wait.
A last important point: after the clean-up, have a look back at how these stocks or ETFs got into your portfolio and attempt to put in place rules that will prevent this from happening again.
*The writer owns CSEW40, DBXWD and PTXTEN.
This article originally appeared in the 19 January edition of finweek. Buy and download the magazine here.
