A checklist for year-end portfolio reviews amid the volatility

• Heightened market volatility in 2022 may have highlighted a difference between clients’ previously stated risk preferences and their actual tolerance for risk.
• Year-end portfolio reviews provide an opportunity to address any changes to client goals or preferences.
• While staying the course is often the best action during a downturn, portfolio clean-ups can help boost client confidence while keeping them on track to meet their goals.

Given the level of volatility in global investment markets in 2022, year-end portfolio reviews and planning conversations with clients over the coming weeks might take on greater significance than usual.

Studies have shown that the experience of a loss is psychologically more intense than that of an equally sized gain¹. So, the drop in global asset markets this year may have been particularly distressing for some clients. Further research suggests that when faced with a perceived threat, i.e., to financial wellbeing, for example, individuals instinctively want to take some form of action to mitigate the threat – and by doing so, analysis suggests one can boost confidence and reinstate feelings of control².

While staying the course through market downturns with a well-diversified, strategic allocation to equities and bonds has tended to reward long-term investors³, staying the course doesn't have to mean standing still.

In this article, we share a checklist of portfolio actions and considerations advisers can take during year-end reviews and planning conversations with clients. The aim of the checklist is to help boost client confidence while maintaining discipline with their investments and ultimately to demonstrate the value of financial advice, particularly at a time of heightened economic uncertainty.

Portfolio review checklist

The strategic mix of equities and bonds in an investment portfolio is the main determinant of long-term investment success, according to research⁴, which is why asset allocation is a good place to start portfolio reviews.

1. Consider rebalancing

The significant volatility in equity and bond markets this year may have caused portfolios to drift further than they normally would from their target allocation, so now might be a good time to rebalance. 

Our research has found that none of the major rebalancing approaches (calendar-based, threshold-based or time-and-threshold) hold a distinct advantage over the others, but there are certain actions and considerations for advisers to help maximise rebalancing efficiency. Find out more about the different rebalancing approaches and how advisers can add value here.

2. Reassess risk tolerance

If clients raise concerns about the downturn this year, it may open the door to a broader conversation about their tolerance for risk. A bad year in the markets should have little long-term impact on a client's attitude to investment risk, but it’s worth checking in and making sure the client is comfortable with their portfolio’s exposure to riskier assets. It’s at times like this that behavioural coaching is particularly important, i.e., reminding the client that you have built a clear plan for them, that it was built to withstand years with negative returns and that staying the course is a key component of that plan.

Despite declines in bond markets this year, we still believe bonds remain the best asset class to act as a counterweight to equities due to the historically low correlation between the asset classes, with bonds often acting as a buffer during periods of equity volatility⁵.

3. Review costs

All our research and experience at Vanguard tell us that costs play a crucial role in investor success – namely that it pays to keep costs low⁶. Whether invested in an actively managed fund or an index fund, each basis point paid by an investor is one less basis point that they receive as a return.

The tougher the investing environment the bigger the proportional impact of an investor’s costs on their final return and the more important it becomes to fight for each basis point. While advisers have no control over when, and by how much, markets will move, they can control how much of the market’s return clients receive and add value by helping minimise investment costs.

4. Stay invested

It might feel counter-intuitive to stay invested in assets that are falling in value, particularly if investors suspect those losses could get worse before they get better. In the current climate, investors also face high inflation eroding real returns. While rising interest rates might make cash seem more appealing than global investment markets, it is important to remember that real returns are likely to be negative after adjusting for the corrosive effects of inflation. Over the long term, equities have historically been one of the best hedges against inflation⁷.

Withdrawing from markets when things get choppy could mean investors forgo significant gains that would have brought them closer to their investment goals, because a few days out of the market can be costly. For example, from 1928 to 2021, there were more than 23,300 trading days in the US stock market. Out of those, the 30 best trading days accounted for almost half of the market’s return⁸, as shown in the chart below. Being out of the market at the wrong time is costly. And many of those best trading days were clustered closely with the worst days in the market, making precise timing nearly impossible⁹.

Annualised returns of US stock market from 1928 until 2021-end

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard calculations, using data from Macrobond, Inc, as at 31 December 2021. Notes: Returns are based on the daily price return of the S&P 90 Index from 1 January 1928 until the 31 March 1957 and the S&P 500 Index thereafter until 31 December 2021 as a proxy for the US stock market. Returns calculated in USD. The returns do not include reinvested dividends, which would make the figures higher for all bars.

Discipline is often the best approach in a downturn

In many cases, the best course of action for investors when markets endure a downturn is to stick with the long-term strategy devised with their adviser at a time when the emotional baggage of recent losses was not an influencing factor. At the same time, the recent volatility may have brought to light a change in the client’s risk preferences or investment goals, or simply an opportunity to conduct a portfolio clean-up.

Our suite of explainers and behavioural coaching aids are designed to help advisers make the most of client interactions and deliver value to investors. Click here to discover and download our marketing resources available to advisers as part of our Vanguard 360 programme.

¹ Kahneman and Tversky, 1979.

² Landau et al., 2015. ‘Compensatory control and the appeal of a structured world’.

³ Source: Vanguard calculations, using data from FactSet. Notes: Comparison of returns for a hypothetical example of 60/40 stock/bond portfolio during and after a sharp market downturn versus going to cash and reinvesting after markets begin to recover. Data between 1 November 2018 and 28 February 2019. Hypothetical 60% stock/40% bond portfolio consisted of US stocks, global ex-US stocks, US bonds and global ex-US bonds. US stocks represented by the CRSP US Total Market Index, US bonds represented by the Bloomberg U.S. Aggregate Float Adjusted Index, Global stocks represented by the FTSE Global All Cap ex US Index, Global bonds represented by the Bloomberg Global Aggregate ex-USD Float-Adjusted RIC Capped Index. Returns calculated in USD.

⁴ G. P. Brinson, L. R. Hood, and G. L. Beebower, 1995. "Determinants of portfolio performance." Financial Analysts Journal 51(1):133–8. (Feature Articles, 1985–1994).

⁵ Source: Vanguard. For more information, see "Hedging equity downside risk with bonds in the low-yield environment", Renzi-Ricci. G and Lucas Baynes, January 2021. Equity returns are derived from the MSCI AC World Total Return Index and bond returns derived from the Bloomberg Barclays Global Aggregate Total Return Index, hedged to GBP. Both equity and bond returns are reported in GBP. Data from Bloomberg LP, using monthly data from January 1988 to November 2020.

⁶ Source: Vanguard. See ‘Principles for investment success’: hypothetical example of the growth of an initial £10,000 investment over a 30-year period, assuming 6% growth per annum, with annual costs of either 0.3%, 0.6%, 0.9% or 1.2%.

⁷ Source: Vanguard’s framework for constructing globally diversified portfolios. Nominal and real returns of Treasury bills, bonds and shares in local currency from 31 December 1900 to 31 December 2020. Calculations using Dimson-Marsh-Staunton global returns data from Morningstar, Inc. (DMS UK Equity Index, the DMS UK Bond Index, the DMS Europe Equity Index, the DMS Europe Bond Index).

 ^{8, 9}  Source: Vanguard calculations, using data from Macrobond, Inc, as at 31 December 2021. Notes: Returns are based on the daily price return of the S&P 90 Index from 1 January 1928 until the 31 March 1957 and the S&P 500 Index thereafter until 31 December 2021 as a proxy for the US stock market. Returns calculated in USD and do not include reinvested dividends.