Mark Fonville, CFP®

16 min read

9 Crucial Components of an Investment Portfolio Review

Updated: 3 hours ago

Are you a high-net-worth investor with over $2 million who is concerned about maximizing your wealth and minimizing risk?

If so, conducting an investment portfolio review is a crucial step towards achieving your financial goals.

With the fast-paced nature of the financial markets, it's easy to lose sight of your long-term financial objectives and get caught up in short-term fluctuations. That's why it's essential to periodically assess your investment portfolio to ensure that it's well-positioned to achieve your financial goals while minimizing risk.

A financial advisor at Covenant Wealth Advisors can provide a personalized investment portfolio review. Take our short quiz and be matched with an experience advisor today!

In this blog, we'll discuss the 9 crucial components of an investment portfolio review that will help you optimize your portfolio for tax efficiency, assess your risk exposure, and stay disciplined in your investment decisions.

Most importantly, it will provide you with a framework to identify potential gaps and blind spots in your investment game plan.

So, grab a cup of coffee and join us as we dive into the world of investment portfolio reviews.

What is an investment portfolio review?

An investment portfolio review is an assessment of your investment portfolio to evaluate whether it's aligned with your financial goals, risk tolerance, and tax efficiency objectives.

It involves analyzing your asset allocation, diversification, risk exposure, management expenses, ownership costs, and tax strategies. The primary objective of an investment portfolio review is to ensure that your portfolio is well-positioned to achieve your long-term financial goals while minimizing risk.

During an investment portfolio review, you may evaluate the performance of your investments, assess the level of risk in your portfolio, and identify areas that require adjustments to achieve your financial objectives. You will also evaluate the tax efficiency of your portfolio by assessing the impact of turnover on your taxes and evaluating your portfolio's tax strategies.

Investment portfolio reviews are typically conducted at least annually, but the frequency may vary depending on your financial situation and investment objectives. For example, at Covenant Wealth Advisors, we review portfolios every couple of weeks to ensure they continue to align with our client's personal situations.

Regular portfolio reviews are crucial for high-net-worth investors who want to maximize their wealth, minimize risk, and optimize tax efficiency.

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Why is an investment portfolio review important?

An investment portfolio review is important for several reasons.

First, it helps you evaluate the performance of your portfolio against your financial goals and objectives. By reviewing your portfolio periodically, you can identify areas that require adjustments to achieve your long-term financial goals.

Once you understand the returns you need to accomplish your goals, you can then start to build a portfolio that gives you the highest probability of accomplishing those returns without unnecessary risk.

Secondly, a portfolio review helps you assess the level of risk in your portfolio. By evaluating your asset allocation, diversification, and risk exposure, you can ensure that your portfolio is well-positioned to achieve your financial objectives while minimizing risk.

Thirdly, an investment review helps you assess the tax efficiency of your portfolio. Taxes can have a significant impact on investment returns, especially for high-net-worth investors. By evaluating your portfolio's tax strategies and assessing the impact of turnover on your taxes, you can optimize your portfolio for tax efficiency and improve your after-tax returns.

Fourthly, an investment portfolio analysis helps you evaluate the expenses associated with managing your portfolio. By evaluating the management expenses and ownership costs of your investment holdings, you can ensure that you're paying reasonable fees for the value provided.

Finally, an investment portfolio review helps you stay disciplined and focused on your long-term financial goals. Market volatility and short-term fluctuations can tempt investors to make emotional investment decisions that can harm their long-term financial prospects. By conducting regular portfolio reviews, you can maintain a long-term perspective and stay disciplined in your investment decisions.

Now, let’s dive into the 9 critical components of an investment portfolio review.

1. Asset Allocation

Asset allocation is the process of dividing your investment portfolio among different asset classes, such as stocks, bonds, and cash. The purpose of asset allocation is to create a diversified portfolio that balances risk and return. By diversifying your investments across different asset classes, you can reduce the impact of market volatility on your portfolio's performance.

Asset class diversification means investing in different types of investments within one category. For example, in the category of stocks, you can invest in big companies, medium-sized companies, and small companies. By investing in different types of stocks, you can reduce the risk of losing money if one type of stock does not perform well.

Investment portfolio review asset allocation example — Asset Allocation Review - For Illustrative Purposes Only. Not Advice.

The asset allocation that you choose will depend on your financial goals, investment time horizon, and risk tolerance.

Asset allocation is a crucial component of investment portfolio management, and studies have shown that it can account for up to 90% of portfolio returns over the long term.

By diversifying your investments across different asset classes, you can achieve a well-balanced portfolio that is aligned with your investment objectives and risk tolerance.

2. Global Diversification

Global diversification involves investing in companies and assets outside of your home country. By investing in global markets outside of the United States, you can reduce your exposure to domestic market risk and benefit from the growth potential of developed and emerging markets.

A proper portfolio analysis should help you understand what your domestic and international exposure is across your entire portfolio.

International Portfolio Diversification Review - For Illustrative Purposes Only. Not Advice or a Recommendation.

But, some investors may be fearful of investing outside of the United States. Perhaps you feel the same way.

Home bias is the tendency for investors to invest most of their money in companies and assets that are located in their own country. This can be a threat to investors because it limits their exposure to other opportunities in different countries that may offer higher returns or lower risk.

Investing only in your own country can be risky because your investment returns may be closely tied to the performance of your country's economy. If your country's economy is not doing well, your investments may suffer. Diversifying your investments across different countries can help reduce this risk and potentially provide higher returns.

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In addition, investing in only one country can also limit your exposure to companies and assets in other countries that may offer unique growth opportunities or may be less affected by market volatility.

For example, in the chart below we provide the returns of US. stock markets (S&P 500) vs non-U.S. developed markets (EAFE) and Emerging Markets (EM) over a period of time.

Asset class diversification report — Index return data only. Indexes are not available for investment and contain no fees or expenses.

As you can see, market returns differ depending upon the year.

It's important for investors to consider diversifying your investments across different countries and not only invest in their own country. While there is no guarantee, this can help reduce risk and potentially provide higher returns over the long-term.

As part of your portfolio review, you should evaluate your exposure to global markets and consider whether your current allocation is consistent with your risk tolerance and investment objectives.

3. Stock Concentration Risk

Stock concentration risk is when you have too much of your money invested in just one company's stock or a small group of companies' stocks. This can be risky because if that company or group of companies don't do well, you could lose a lot of money.

For example, if you have a lot of your money invested in just one technology company and that company doesn't do well, the value of your investment could go down a lot and you could lose a lot of money.

Here's what a stock concentration risk analysis may looks like:

Investment portfolio stock concentration risk analysis — Concentration portfolio risk review - For Illustrative Purposes Only. Not Advice.

There have been many well-known companies that have filed for bankruptcy in the past. Here are a few examples:

Enron - In 2001, Enron, an energy company, filed for bankruptcy after it was discovered that the company had engaged in accounting fraud.
Lehman Brothers - In 2008, Lehman Brothers, a global financial services firm, filed for bankruptcy as a result of the subprime mortgage crisis.
Toys "R" Us - In 2018, Toys "R" Us, a popular toy retailer, filed for bankruptcy due to declining sales and increased competition from online retailers.
Kodak - In 2012, Kodak, a well-known photography company, filed for bankruptcy due to a decline in demand for its film products and its failure to successfully transition to digital photography.
Sears - In 2018, Sears, a department store chain, filed for bankruptcy after years of declining sales and increased competition from online retailers.

These examples show that even large and well-known companies can face financial difficulties and may not be immune to bankruptcy. It's important for investors to carefully evaluate the financial health and stability of companies before investing in them.

The truth is that bankruptcies happen all of the time as illustrated in the chart below:

US bankruptcy filing by year and importance of avoiding concentration risk. — Source: SPGlobal

It's important to have a diversified portfolio, which means investing in different types of companies and industries, to help reduce the risk of losing a lot of money if one company or sector does poorly.

Sometimes, you may own holdings, such as mutual funds that have the exposure to the same stocks. As a result, your portfolio may have increased exposure to a single stock without your knowledge.

As part of your portfolio review, you should evaluate your exposure to individual stocks and sectors and consider diversifying your holdings to reduce concentration risk.

4. Equity Factor Analysis

Popularized by Nobel Prize winning economist, Eugene Fama and Professor Kenneth French, equity factor exposure refers to how much a stock or investment is affected by certain characteristics or factors, such as the size of the company, the value of the company, or how profitable the company is.

The multi-factor model of investing by Fama and French suggests that the performance of stocks is not just affected by the overall market, but also by other factors such as company size, value, and profitability. These factors are important to consider when building an investment portfolio because they can affect the risk and return of investments.

By diversifying across different factors, investors can potentially achieve higher returns while managing their risk exposure.

For example, here is a sample equity factor analysis for an investment portfolio. The red triangle denotes the hypothetical investor's current portfolio (slightly tilted toward large and growth companies). The green circle denotes the hypothetical recommended portfolio that includes tilting the stock portfolio toward more small and value companies.

Equity factor portfolio analysis example — Equity factor portfolio analysis - For Illustrative Purposes Only. Not Advice.

Your investment portfolio review should help you understand how much or how little exposure you have toward these factors. Understanding your factor exposure can help you understand how to potentially improve expected returns going forward.

But, why should you consider tilting your stock portfolio toward factors in the first place?

Exposure to Value Companies

Value companies are companies that are undervalued relative to their peers. Value stocks tend to outperform growth stocks over the long term, but they can be more volatile in the short term.

As part of your portfolio review, you should evaluate your exposure to value stocks and consider whether your current allocation is consistent with your investment objectives.

Exposure to Small Companies

Small companies are companies with a market capitalization of less than $2 billion. Small-cap stocks tend to be more volatile than large-cap stocks but offer higher growth potential over the long term. As part of your portfolio review, you should evaluate your exposure to small-cap stocks and consider whether your current allocation is consistent with your investment objectives.

Small cap performance relative to large cap

Exposure to Companies with High Profitability

Companies with high profitability tend to generate consistent earnings and have a lower risk of bankruptcy. As part of your portfolio review, you should evaluate your exposure to companies with high profitability and consider whether your current allocation is consistent with your investment objectives.

High profitability stocks vs low profitability stocks

As you can see, it's important to understand how much exposure you have in your investment portfolio to different factors.

Be sure to include a factor analysis in your investment portfolio review.

5. Fixed Income Quality

At Covenant, we view bonds as an important component of building investment portfolios. In our view, they should be used primarily to reduce risk in a portfolio and provide a source of liquidity for cash needs or income.

But, different types of bonds have different levels of risk.

Bonds are rated based on their credit quality, which refers to how likely it is that the borrower will be able to pay back the money they borrowed. This rating is assigned by credit rating agencies such as Moody's and Standard & Poor's.

The rating is usually represented by a letter grade, such as "AAA," which is the highest rating, or "D," which is the lowest rating. Bonds with a higher rating are considered less risky because the borrower is more likely to be able to pay back the money they borrowed. Bonds with a lower rating are considered more risky because there is a higher chance that the borrower may not be able to pay back the money.

When investors are looking to buy bonds, they may consider the credit rating to help them determine how risky the investment is.

Fixed income credit quality analysis. - For illustrative purposes only. Not advice.

Bonds with higher ratings may have lower returns, while bonds with lower ratings may have higher returns, but also higher risk. It's important to carefully consider the credit rating and other factors when making investment decisions.

As part of your portfolio review, you should evaluate the quality of your fixed income holdings and consider whether your current allocation is consistent with your risk tolerance and investment objectives.

6. Fixed Income Maturity

Fixed income maturity refers to the length of time until the bond's principal is repaid.

Bonds with longer maturities tend to offer higher yields but are more sensitive to changes in interest rates. Bonds with shorter term maturities are less sensitive to movements in interest rates.

Here is an example of a fixed income maturity analysis:

Fixed income maturity analysis review — Fixed Income Maturity Analysis Review - For illustrative purposes only. Not advice.

A large increase in interest rates is the primary reason that bond prices declined substantially in 2022!

As part of your portfolio review, you should evaluate the maturity of your fixed income holdings and consider how movements of interest rates may impact your holdings.

7. Investment Costs

Investment costs are the expenses that investors pay for buying, holding, and selling investments. These costs can include fees, commissions, and other expenses related to managing and maintaining an investment portfolio.

Some examples of investment costs include brokerage commissions for buying and selling stocks, mutual fund fees, account maintenance fees, and advisor fees. These costs can vary depending on the type of investment and the investment firm you are working with.

Investment costs are an important consideration for investors because they can impact the overall return on investment. High investment costs can reduce the return on investment, while lower investment costs can increase the return on investment.

Mutual fund and ETF expense ratios

When you invest in a mutual fund or exchange traded fund (ETF), you pay a fee for the professionals who manage the fund and make investment decisions. This fee is called the expense ratio, and it is expressed as a percentage of the total amount of money invested in the fund.

Expense ratios are important because they impact the overall return on investment. A high expense ratio means that a larger portion of your investment is going towards paying fees, which can lower your overall returns. Conversely, a low expense ratio means that more of your investment is going towards buying assets, which can increase your overall returns.

It's important to carefully consider the expense ratio when choosing a mutual fund or ETF to invest in.

Cost of Turnover

The cost of turnover in a stock portfolio is the expense of buying and selling stocks within the portfolio. When stocks are bought and sold frequently, the cost of turnover can add up quickly and impact the overall return on investment.

One factor that can impact the cost of turnover is the bid-ask spread. The bid-ask spread is the difference between the price at which a buyer is willing to buy a stock (the bid price) and the price at which a seller is willing to sell the stock (the ask price). The bid-ask spread represents the cost of executing a trade and can impact trading costs.

For example, if the bid price for a stock is $10 and the ask price is $11, the bid-ask spread is $1. If an investor wants to buy the stock, they will have to pay the ask price of $11, which is higher than the bid price. This difference in price represents the cost of executing the trade, and can impact the overall return on investment.

According to academic studies, the added cost of turnover in an investment portfolio can vary depending on several factors, such as the frequency of trading, the type of assets traded, and the size of the portfolio.

Some studies have suggested that the cost of turnover can range from as low as 0.1% to as high as 2% or more per year, depending on these factors. In general, higher turnover rates tend to result in higher trading costs and lower returns over the long term.

Here are a few examples of academic studies that have examined the impact of turnover on investment costs:

"Turnover and Mutual Fund Performance" by Mark Carhart (1997) - This study found that mutual funds with higher turnover rates tended to have higher expenses and lower returns.
"Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors" by Brad M. Barber and Terrance Odean (2000) - This study found that individual investors who traded frequently tended to have lower returns due to higher trading costs and other factors.
"Portfolio Turnover and Equity Trading Costs" by Robert M. Dammon, Chester S. Spatt, and Harold H. Zhang (2004) - This study found that higher portfolio turnover rates tended to result in higher trading costs, which can impact investment returns over time.
"The Costs of Mutual Fund Turnover" by Ari Levine and Yao Lu (2010) - This study found that higher mutual fund turnover rates tended to result in higher expenses and lower returns for investors.

When reviewing your investments, your portfolio analysis review should include an evaluation of all current expenses and suggestions for potential investments that may help reduce total cost of ownership.

8. Tax Efficiency

Tax efficiency is an important consideration for high-net-worth investors, as taxes can have a significant impact on investment returns. As part of your portfolio review, you should assess the impact of turnover on your taxes and evaluate your portfolio's tax strategies, such as tax-loss harvesting, tax-efficient fund selection, and the specific location of your investments across different types of accounts.

Studies have shown that tax-efficient investing can significantly improve after-tax returns for investors. The exact amount of improvement can vary depending on several factors, such as the investor's tax bracket, the type of investments held, and the overall investment strategy.

One study conducted by Vanguard found that tax-efficient investing can improve after-tax returns by as much as 2% per year, compared to a less tax-efficient approach.

9. Risk Tolerance Assessment

Every investor wants great returns. But stock markets don’t always go up. If you can’t tolerate the tough periods, then you may bail on your investment plan at exactly the worst time. As a result, you won’t be around when markets potentially rebound.

A personal risk tolerance assessment is a tool that helps investors determine their individual comfort level with investment risk. It typically involves a series of questions or a questionnaire designed to gauge an investor's willingness to take on risk in pursuit of potential returns.

The assessment considers factors such as the investor's age, financial goals, investment experience, and other personal factors that may impact their willingness to take on risk. Based on the answers provided, the assessment assigns a risk tolerance level, which can help guide investment decisions.

Knowing your personal risk tolerance is important when building an investment portfolio because it can help you choose investments that align with your goals and comfort level. By selecting investments that match your risk tolerance, you can potentially achieve your financial objectives while minimizing the likelihood of significant losses due to market volatility.

It's important to note that risk tolerance assessments are just one tool to consider when making investment decisions. Other factors, such as investment goals, time horizon, and financial situation should also be taken into account when determining the appropriate investment strategy.

As part of your portfolio review, you should evaluate whether your actual portfolio risk is consistent with your risk tolerance. If your actual risk is higher than your risk tolerance, you may need to adjust your asset allocation or diversify your holdings to reduce risk.

Conclusion

Conducting an investment portfolio review is an essential component of managing your investment portfolio.

By evaluating your asset allocation, diversification, risk exposure, management expenses, ownership costs, and tax strategies, you can improve the likelihood that your portfolio is well-positioned to achieve your long-term financial goals while minimizing risk.

As a high-net-worth investor, optimizing your portfolio for tax efficiency is critical to achieving your financial objectives. By considering the 11 components discussed in this blog, you can move several steps closer to ensuring that your investment portfolio is optimized for tax efficiency and aligned with your financial goals and risk tolerance.

So, where do you start?

We can help simplify the entire investment portfolio review process for you.

At Covenant Wealth Advisors, we specialize in analyzing investment portfolios and helping high-net-worth individuals manage their wealth for a more secure financial future.

If you have over $1 million in savings and investments (excluding real estate), click here to request a free retirement assessment from one of our CERTIFIED FINANCIAL PLANNER ™ professionals.

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Disclosures: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss.