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This article first appeared in the 4th quarter 2018 edition of Personal Finance magazine.

Many investors find themselves with highly complex and unconsolidated investment portfolios, which are unknowingly hard to manage and costly to change. These messy portfolios can match the complexity of hedge funds without the expertise to manage them. There’s much to be said for striving for relative simplicity in wealth management, which, in the majority of instances, translates into overall better returns. Consolidated portfolios allow you to invest with clear goals and objectives in mind and with well-managed risk-return relationships.  

What is a messy portfolio?  

A messy portfolio is perhaps best explained as the ownership of a group of assets that don’t resemble any structure and are lacking a defined investment strategy. Decisions to purchase the assets have been made independently with no relationship to previous choices. They’re groups of assets that in their entirety don’t have the correct asset allocation and level of risk required to obtain an investor’s objectives. To complicate matters, investments in messy portfolios are also usually haphazardly scattered across various sources, including stock brokers, asset management companies, banks and linked-investment services provider (Lisp) platforms.

They can be comprised of property (commercial and private), businesses, a variety of retirement annuities (RAs), structured products, unit trusts and shares, which appealed to the investor along the way. Some investors in their 50s and 60s have a combination of old-fashioned (insurance-based) RAs and newer ones that are investment-linked. This can occur as they change jobs in their careers and transfer their pension funds into preservation funds or RAs without an overall retirement strategy.  

Retirees may have an array of life annuities and living annuities, with no plan regarding the underlying investments based on total retirement capital, their age, drawdown amount or risk profile.   

Portfolios can also be unconsolidated from an insurance point of view. You may have many different policies, including group cover from employers, business policies, and a collection of personal policies deemed to be necessary. You may have too little, too much or duplicate cover, with no clear strategy regarding beneficiaries, links to your will, and consideration of long-term liabilities.

What are you losing out on?

Investment portfolios can lack structure, as there may be a compelling rationale to buy an asset at a given point in time, but you have no framework to determine whether or not to retain the asset in the long term. The investment thesis may deteriorate or change. All too often, messy portfolios originate in the quest to avoid fees at the cost of valuable advice.

Wealth managers typically have structured processes in place and conduct regular reviews to ensure that your investments remain linked to specific objectives. They have access to sophisticated planning software, which assists in determining the basics, such as how much capital you need for retirement and what changes are required to influence the outcome. Furthermore, investment portfolios are continually monitored by investment committees and discretionary fund managers, who actively manage portfolios and identify opportunities as the markets change. They also have access to other professionals, including tax, accounting, legal and estate planning experts. There is significant value in the coordination of these diverse aspects of wealth management.

Some investors choose to have multiple advisers with different perspectives and frames of reference, as they believe this is a diversification strategy in itself. However, it’s imperative to differentiate between advice diversification, which is very often counterproductive, and portfolio diversification, which is critical. Within the multi-manager unit trust environment, well-constructed portfolios typically tend to blend best-of-breed managers from various institutions with different portfolio management styles: value, quality, momentum and earnings-revision. Simply building a portfolio of value-oriented managers is hardly a diversification strategy.

Investors who base each decision on the possibility of generating maximum return from each investment are likely to develop a gap between expectation and reality, and it is this void that all too often sets the scene for poor decision making.  It’s far wiser to frame decisions on specific investment objectives with reasonable time-frames in mind, and then to select the appropriate instruments. This is what is traditionally referred to as goals-based wealth management.

Wealth matters can easily become disorderly when investors fail to reveal all their assets to their adviser. They may be uncomfortable about decisions that they’ve made independently or want to avoid fees on some of their investments, which is understandable but not wise. Investors might also want to make independent choices about “new money” such as bonuses and inheritances.

Some people are merely mavens by nature and like to take things into their own hands. They collect information from various sources and people they know within the investment industry, formulate their own opinions and are happy to tolerate the risk that goes along with their independent thinking. The reality is that it’s very challenging for independent investors, regardless of their profession or background, to choose wisely from many investment options that present themselves and to monitor continuously changing information.

Also, there’s the fear factor! Many investors avoid a thorough financial needs analysis because they fear the truth and want to maintain an inappropriately lavish lifestyle. Even worse, there’s the “I can’t be bothered” factor and “I would rather spend my time having a good time with family and friends than getting good financial advice”.  

Messy portfolios are risky and may result in lower overall returns or even loss

The most significant risk of having an unconsolidated portfolio is that you may not achieve your primary investment objectives, such as having enough capital for retirement or desired lifestyle choices. The process of managing asset allocation and implementing changes becomes even more critical as you age, as there’s less time to make changes and recoup losses that may have occurred along the way.

When investors have a multitude of RAs with no clear strategy in place, there’s the real risk of insufficient capital for retirement. The decision regarding RA consolidation must be carefully considered because, if it’s an insurance-based product, there may be a significant penalty if the contract is cancelled. Should there be sound reason to cancel the contract, a careful calculation is required to ensure that the penalty can be recouped if the funds are moved into an investment-linked RA that may have lower costs and provide you with more flexibility.

Investors can also waste a significant amount of capital when they rely on multiple advisers. Advisers usually have a sliding fee scale based on the total capital value – the greater the amount of capital invested, the less the fee as a percentage of capital. If you are overpaying in fees, the long-term effect can be quite severe. Just as compound growth works in your favour regarding capital growth, it works against you regarding costs and forgone opportunities.

Few investors take regular advantage of their annual capital gains tax (CGT) exemption. CGT is incurred when you sell an asset that has risen in value: 40% of the gain is added to your net income and taxed at your marginal tax rate. There is, however, a R40 000 annual exemption, which should ideally be used annually. If a portfolio is consolidated, yet actively managed by a professional adviser, it’s more likely that this opportunity will be used. A sale should occur even if it means repurchasing the investment at the same price because, in doing so, the base cost is reset at a higher level, which will reduce future CGT.

The loss of time, the most precious commodity of all, is a significant risk of having a messy portfolio unless of course, you gain satisfaction from your own process. If you do not enjoy the role but commit to it, there’s the opportunity cost of less stressful and potentially more lucrative returns from another source. Valued leisure time, added time with family and friends and, of course, more scope and dedication to one’s vocation are clearly better ways of directing energy. These days, there’s much to be said for outsourcing as many important functions as possible, where one has little expertise. Why not delegate an investment function to a team of highly qualified professionals who are continually scouring the markets for opportunities?  

A messy portfolio also presents risks from an estate planning point of view. It may be hard to determine the real value of each asset in your estate, which can make decisions on the distribution of your wealth to heirs more difficult. The executor may need more time (sometimes an additional few years) to wind up a messy estate. This may put pressure on your heirs if they are dependent on their inheritance. Some assets may even be overlooked and discovered years down the track.

You can also be exposed to significant risk if there’s no clear management of life assurance policies. If you are over-insured, there’s the opportunity cost of compound growth on funds that could be channelled into an investment portfolio.  If you are under-insured, there’s the obvious risk that your dependents may not have enough capital to sustain their lifestyles and insufficient liquidity to cover long-term liabilities.

Costs of consolidation

The barrier to consolidation is usually the cost of doing so. CGT is usually the most noteworthy cost to consider, as there may be the need to sell assets that have gained in value but are no longer appropriate to hold. The sale of assets can be done in phases over time, making use of the annual R40 000 exemption. In some instances, there is a benefit in delaying a sale and profiting from the compound growth of deferred taxes. However, you should always bear in mind that it’s not always appropriate to allow “the tax tail to wag the investment dog”.

Another cost of consolidation is the emotional strain. Investors often find it hard to sell property they’re attached to, such as a family holiday home, family business or inherited assets.  It’s also hard to sell an asset that performed historically well but is too risky to hold over the long-term in future. For instance, if your portfolio comprises mainly offshore equities, it may be hard to sell when the rand is weakening, even if you are approaching retirement, plan to live in South Africa, and fundamentally need a more conservative portfolio.

There may also be the cost for a thorough analysis of the messy portfolio and the development of a revised plan. The good thing is that there are no costs when unit trusts are transferred from one Lisp platform to another, and the benefits of scale typically result in lower fees overall. There are also no upfront fees permitted on retirement fund transfers.  

The biggest gains

The most significant benefit of a consolidated portfolio is the ability to actively and effectively manage capital as the variables change. These include your life circumstances, the markets and the emergence of new investment vehicles.  It’s important to consider the characteristics of each investment and the potential impact on the overall portfolio in the short- and long-term. This process almost always enhances the overall return, and there’s a far greater probability of meeting investment objectives.

The greatest gift of consolidation is peace of mind and knowing that your hard-earned money is invested in an optimal manner and that each investment has a place and purpose in the portfolio. It’s a relief to rely on a portfolio management process that includes ongoing adjustments when necessary.

A streamlined portfolio allows you to focus on improving your overall risk-adjusted performance rather than trying to determine how it all works. It’s not necessary to be held hostage by money and complexity. There’s much truth in the quote by author and physician Martin Fischer: “Knowledge is a process of piling up facts; wisdom lies in their simplification”.

Mark MacSymon, a Certified Financial Planning professional, is the Financial Planning Institute’s 2017/18 Financial Planner of the Year and wealth manager at Private Client Holdings.

PERSONAL FINANCE