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Your portfolio probably sucks.

why is my portfolio bad

Here are the 3 most common issues I see in retirement portfolios and how to fix them.

From 1996 to 2015, the average investor underperformed the S&P 500 by 6.1% per year. That’s a lot.

To put it in perspective, had you invested $100,000 in the S&P 500 in 1996, you would have had $483,665 by the end of 2015.

If you invested like the average investor, you would have only $151,535.

We’re talking a major difference here. $332,130 is real money.

This difference is why I say that your portfolio isn’t great. Statistically, half of us are even worse than the average I mentioned above.

There are three main issues I see when I review portfolios. I’m going to tell you the issues and then I’m going to show you how you can build a portfolio that avoids these problems.

The biggest issue I see is behavioral, not structural. Investors tinker with their portfolios and chase returns, leading them to buy high and sell low.

For the rest of the issues, keep on reading.




  • 3 Problems I see with most portfolios

  • 3 Ways to build an efficient portfolio

  • 3 Items to watch for when selecting investments

Portfolio Problems

1. Chasing Portfolio Returns

The biggest portfolio problems are behavior driven, not structural. These problems arise when an investor wants to chase returns, which almost always leads to buying high and selling low. It’s simple to want to buy what has gone up, with the expectation that it will continue to rise, but there’s a reason most investments come with the warning that past performance is no guarantee of future results.

When you’re selecting investments as a near-retiree, you need to be looking at investments that you’re comfortable holding for the long-term. Most of the underperformance that I mentioned above is due to getting impatient and selling an investment when it doesn’t immediately perform at the expected level.

You can see this empirically from the S&P return. The S&P is just an index of the 500 largest publicly listed companies in the US. An investor could have gotten this return by merely buying the index and not giving it another thought. Instead, the average investor buys and sells, trying to beat the index. Study after study has shown that beating the index is incredibly hard for professionals who have nearly unlimited resources and time on their side, much less for the average investor.

As an aside, run from any financial advisor who says that they can beat the market. Research shows that just isn’t true. If your advisor thinks they can beat the market, they’re either ignorant of evidence based investing principles or they’re not being truthful. I can’t beat the market consistently and it’s unlikely another advisor can either.

2. Ignoring Expenses

Most investments have internal expenses, like management fees and 12b1 fees. These internal investment expenses add up over time. The average active mutual fund has internal expenses of ~.5%, but I often meet people with investments significantly more expensive than that.

Imagine you have $100,000 invested. If the account earned 7% a year for the next 25 years and had no costs or fees, you'd end up with about $542,743.

If, on the other hand, you paid 1% a year in internal expenses, after 25 years you'd have about $429,187.

The 1% you paid every year would wipe out over 25% of your final account value. 1% doesn't sound so small anymore, does it?


3. Not optimizing for taxes

Most investors own the same investments in each account, regardless of the type of account. This approach is simple, but it’s a missed opportunity.

You know that not all accounts have the same tax treatment. Roth IRA’s are tax-free at withdrawal, Traditional IRA’s are tax-deferred until withdrawal and then taxed as ordinary income, and taxable accounts have tax due each year on gains and dividends, but offer the benefit of a lower long-term capital gains tax rate.

Likewise, not all investments are equally tax efficient.

For example, growth stocks are typically more tax-efficient than value stocks which pay a dividend. The reason is because growth stocks are taxed only when you sell and realize a gain. Growth stocks rarely pay dividends, which brings me to my next point. Dividend paying stocks are going to throw off taxable income each year which you can’t control.

Likewise, Exchange Traded Funds, or ETF’s, are typically more tax efficient than actively managed mutual funds. ETF’s, due to the way they’re structured, don’t distribute capital gains. Mutual funds can distribute capital gains, which are taxable, even in years that the fund actually loses money. Personally, I rarely use mutual funds in taxable accounts for this very reason.

Finally, bonds pay taxable income each year, unless they’re a tax-free municipal bond.

So when I say optimizing for taxes, I mean that you need to consider what type account holds each investment. This is both an art and a science, but effectively you want to place tax-efficient investments in taxable accounts, while placing less tax-efficient investments like bonds and dividend paying stocks in tax-advantaged accounts.

For many portfolios I manage, the end result is something like this:

My goal for this is to maximize growth in the taxable account, where it can take advantage of the lower long-term capital gains rates, and in the tax-free Roth IRA. Likewise, I prefer to minimize the growth in the Traditional IRA, as having a large IRA creates a tax time bomb once you have a Required Minimum Distribution. That’s a topic for another day though.


How to Build a Portfolio

  1. Decide on overall allocation. You need to consider both your risk tolerance, the amount of volatility you can handle, and your risk capacity, the amount of risk you need to take in order to be successful. This allocation might be 60/40 stocks to bonds, it might be 90/10. This is totally dependent on your situation. Just be sure to choose an allocation that you can stick with during both good times and market downturns.

  2. Decide on how much complexity you want in your portfolio. There’s a quickly decreasing marginal benefit to additional complexity in a portfolio. That’s a fancy way of saying that you can get 80% of the benefit for 20% of the time and effort. Some investors want to be completely hands off. They buy Vanguard Total Stock Market Index for equities and the Aggregate Bond Index ETF for bonds. They balance this into the overall allocation they decided on earlier, then they set it and forget it…except the few times a year they rebalance. The flip side to this is breaking a portfolio down into individual sectors or styles, adding in various flavors of international and emerging market exposure, and maybe even looking at alternative investments like REIT’s, private equity, or venture capital. Neither option is bad, frankly it’s more of a style question. The optionality in the second portfolio can be beneficial but it’s also significantly more work. Plenty of retirees are happier with the simple and direct approach, as they have more interesting ways of spending their time. Oh, and there’s always the option to pay someone to manage your money for you. That is something I do for clients.

  3. Decide on allocation of investments within each individual account. Most retirees have the bulk of their assets in a retirement account, either a 401(k) or Traditional IRA. If that’s all you have, there’s nothing wrong with that. You can ignore this point. If you do have accounts of each type, with sufficient assets in each, you want to make sure you’re maximizing your tax efficiency by putting the tax-efficient investments in the taxable accounts and the less tax-efficient investments in the tax-free and tax-deferred accounts. Know that this is both an art and a science. Optimizing your allocation for taxes takes into account constraints like the size of each account, your overall allocation between stocks and bonds, and how much effort you want to put into it.


Choosing Investments

  1. Focus on expenses. Research shows that expense is a better predictor of future returns than past performance. Remember that internal expenses matter.

  2. Ignore the noise. Stay away from CNBC and mute Jim Cramer. There’s an entire industry dedicated to selling you the latest and greatest investment. Ignore the dozens of lists proclaiming to know the 10 Investments You Need This Year. Instead, build a quality portfolio and stick with it.

  3. Make sure the fund does what it says. When it comes to index funds, there are two things I look for. First, expense, which I already mentioned. Second, does the fund match it’s style target? This is called tracking error, which you want to minimize. When I build portfolios, I typically use ETF’s for exposure to a parts of the market like Large Cap Growth. When I look at an ETF, I know the index it should be tracking. For Large Cap Growth, the appropriate index is typically the Russell 1000 Growth Index. I want to make sure that whichever ETF I’m considering actually tracks that index. You can do this by looking at the tracking error. You want a small tracking error, .5% or lower.


 Here’s what I’m reading


Jeb Jarrell

Founder & Retirement Advisor

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