Good and Bad Reasons to Change Your Portfolio

The other day, a friend asked me if I knew of any good investments for 2012. “I have no idea,” I said.

Don’t you write a column about investing, doofus?

He didn’t actually say that, but I could tell he was thinking it.

I told him my investments are the same this year as last year: a diversified portfolio of stocks and bonds, held in low-cost index mutual funds. Boring answer, but investing is boring, when you do it right.

This got me thinking, though. There are plenty of reasons to make changes to your portfolio; some are good reasons, and some are more likely to end with you dressed in a barrel and suspenders.

I came up with five good reasons to make a change to your portfolio before realizing that they all have something in common: they don’t require predicting the future.

The Good Reasons:

More diversification. Diversification lowers the risk of your portfolio without lowering its expected return. That’s why it’s often called “the only free lunch in investing.” Here are a few ways to order off the free menu:

-If you invest in individual stocks, switch to a broad stock market index fund.

-If you only invest in US stocks, add international stocks.

-If you only invest in stocks, add bonds.

Lower costs. As Vanguard founder John C. Bogle puts it, in investing, “You get what you don’t pay for.” If you own expensive mutual funds charging an expense ratio of 0.5% or higher, you can save a ton of money by choosing cheaper funds. If your 401(k) only offers expensive funds, lobby for better investment options.

Bring your portfolio more in line with your risk tolerance. If you sold out of stocks in 2008-09, or couldn’t sleep because you were worried about all your money disappearing, now you know what risk really feels like. Now that you know, lowering your stock allocation—that is, putting a smaller share of your money in stocks and more in bonds—isn’t an admission of defeat; it’s a step on the path to success. Just put it in writing so that next time everyone is saying stocks will go up forever, you don’t end up surprised again when they don’t.

Simplify. If you have too many overlapping funds or a bunch of leftover 401(k)s from previous jobs, it’s worth consolidating down to as few accounts and as few funds as you can. People with complicated portfolios tend to lose track of what they own and why. You’ll probably end up more diversified and with lower costs by simplifying, too.

Get tax-efficient. Tax-efficiency is probably the most incomprehensible topic in investing. I’ll take a crack at explaining it in a future column, but for now I’ll just file it under “good reasons” and leave it at that.

The Bad Reasons:

A friend gave you a tip. Professional investment analysts go blind staring at computers 60 hours a week to find the best investments. Does your friend really know more than they do? I’m not just being a jerk, because when you buy that can’t-lose investment, it’s almost certainly a professional doing the selling—and he’s selling because he thinks it’s a loser.

You heard something scary in the news. Thanks to the internet, you can find terrifying and seemingly actionable financial news 24-7. Gold is a sure thing! Gold is a bubble! Bonds are doomed! Double-dip recession! Christina Aguilera meltdown! Unfortunately, you can find a bullish or bearish expert for any type of asset, and none of them are any better than a Ouija board at predicting the future. My favorite example of this is bonds. So-called experts have been predicting a “bond bubble” or impending bond crash for over two years. Their arguments sound very convincing. The bond market has been unconvinced, however, because bond prices keep going up. Naturally, at some point that will change—probably around the time experts start screaming to buy bonds because you can’t lose.

Any time you consider making a change to your portfolio, ask yourself: am I doing this to get more diversified, lower costs, bring my portfolio in line with my risk tolerance, get tax-efficient, or simplify my holdings? Or am I trying to predict the best or worst investment of 2012, something no one can successfully do until 2013?

Did I leave out any good or bad reasons? Please let me know in the comments.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.