Step 10
Level: beginner
The portfolio needs to be reviewed when there are signals that the goals, risks, theses or weights have deviated from the original plan. If only looking at each individual position, investors easily ignore the aggregate risk of the entire asset.
Review signals include skewed weights, an out-of-bounds position, a change in fundamental thesis, an excessive drawdown, new cash needs, a change in personal income, or a macro environment that changes portfolio risk. Review does not mean you have to trade. A good portfolio needs to both serve its goals and withstand fluctuations and changes in investors' lives.
When there are clear rules on weight, review, rebalancing and stress testing, investors are less likely to have to make decisions in a state of panic or excitement.
The portfolio needs to be reviewed when there are signals that the goals, risks, theses or weights have deviated from the original plan.
Managing a portfolio is different from choosing a good investment idea. A good asset can become risky if the weight is too large, the time horizon is unsuitable or the correlation with the rest of the portfolio is too high. Therefore, the focus of Step 10 is on how to run the portfolio according to the chosen goal.
Review signals include skewed weights, an out-of-bounds position, a change in fundamental thesis, an excessive drawdown, new cash needs, a change in personal income, or a macro environment that changes portfolio risk. Review does not mean you have to trade.
Portfolios should be evaluated in three layers. The first layer is the goal: what the portfolio is meant to serve and for how long. The second layer is structural: asset weights, correlation, liquidity and concentration risk. The third layer is operational: when to review, when to rebalance, when to reduce risk, and when to do nothing.
Distinguish between signals that need to be observed, signals that need to be reviewed, and signals that require action.
Portfolio rules need to be measurable. For example: maximum weight of a position, minimum cash weight, rebalancing threshold, drawdown level to review or stress test schedule. If the rule is just a general intention, it is often broken when the market is volatile.
Reviewing only the portfolio when there has been a large loss or when the market has negative news.
Mistakes often do not come from a single position, but from many small deviations that accumulate: excessive weight, shared-source risk, failure to rebalance, lack of cash or emotional behavior. Good portfolio management is about detecting these deviations before they become major losses.
Signs that the portfolio needs to be reevaluated compared to the plan.
Signs strong enough to buy, sell, reduce position size or rebalance.
The initial assumption about the asset is no longer true or has weakened.
Portfolios can serve long-term growth, capital preservation, income generation, medium-term goals or a combination of goals.
Portfolio risk can come from asset class, industry, individual positions, liquidity, leverage, correlation or investor behavior.
The portfolio needs rules on weight, rebalancing, review, stress testing, cash and action triggers.
Application in portfolio management
A doubling of a stock can cause the weight to exceed the limit. Although the thesis is still good, the portfolio needs to be reviewed to decide whether to keep, reduce or rebalance.
Actual risks
Reviewing only the portfolio when there has been a large loss or when the market has negative news. When this happens repeatedly, the portfolio can deviate from its original goals, with the investor only realizing after the damage has been done.
Returns alone do not show what risk the portfolio is taking on. Monitor weight, drawdown, liquidity and target deviation.
If investors do not know when to review or rebalance, they can easily delay until emotions take over.
Reviewing only the portfolio when there has been a large loss or when the market has negative news. Safety depends on the source of risk and concentration, not just the number of assets.
Exercise 1 - reflection
Is your current portfolio showing any issues that signal a need to review or rebalance the portfolio? Describe with data if possible.
Exercise 2 - case_study
A doubling of a stock can cause the weight to exceed the limit. Although the thesis is still good, the portfolio needs to be reviewed to decide whether to keep, reduce or rebalance. Identify portfolio risks, signals that need to be reviewed and define the appropriate action.
Exercise 3 - action_plan
Create five portfolio operating rules that you will use over the next 12 months.