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Portfolio Perspectives

Explore the intersection between timely topics and potential effects to your investments in Portfolio Perspectives reports.

July 15, 2020

Advice & Research

Gregory Teets, Director of Markets & Portfolio Advice

David Furst, Advice Strategy

Purposeful Portfolios

By its nature, investing is an optimistic, forward-looking endeavor: We forego spending today, in exchange for the potential of greater rewards tomorrow. In many cases, investing means planning for a specific goal—funding a child’s education, ensuring a comfortable retirement, traveling the world, or leaving a legacy. However, making these goals a reality requires a more proactive approach to building and managing wealth. Investors can potentially achieve better outcomes and more consistent results with portfolios that are:

  • Intentionally Constructed: Your portfolio should be aligned with your financial goals and personalized to your values and circumstances.
  • Diligently Assessed: The outlook for industry, financial markets, and the global economy isn’t static. Your portfolio shouldn’t be either.
  • Routinely Stress-Tested: Truly understanding your portfolio’s risk and performance over time is vital to sticking to your plan and remaining confident in your financial future.
  • Regularly Rebalanced: Small market changes over time can culminate in big deviations from your plan and put your goals at risk.

Intentionally constructed

Many of us can relate to the feeling of dread when we look over the sea of items accumulated over time in our basements or garages; some of which are still useful, while others should probably just be discarded. Similarly, investment portfolios should not become a ‘damp basement’ strewn with the hot stocks of yesteryear. A portfolio should be intentionally constructed to align with your investing goals and incorporate your personal values.

We believe that every client should have an Envision® Plan because the planning process is an effective way to identify and prioritize goals, align your investments to an efficient asset allocation, and track progress over time. Our research1 shows that clients with a plan feel better prepared for retirement, and are more comfortable talking to their Financial Advisor about their goals.

To illustrate this process, the chart below depicts a hypothetical portfolio with an Envision® Plan. As the portfolio grows, the balance fluctuates. However, it remains within the ‘Target Zone’ which takes into account the client’s personalized financial goals. This process provides lane-markers over time so that a long-term focus is maintained and any adjustments necessary along the way can be made.

Envision® Plan Over TimeEnvision® Plan Over TimeSource: Wells Fargo Advisors. For illustrative purposes only. Chart does not represent any specific investment, portfolio, yield, return, or experience of individual investors. The Target Zone represents an Envision Plan with a score of 75 to 90 indicating a reasonable level of confidence that included goals can be achieved.

Even if there isn’t an explicit plan, a portfolio likely has an implicit purpose, such as passing assets on to heirs or acting as a cushion against unforeseen events. Developing a common understanding of that purpose can be helpful in providing guidance and keeping the portfolio on track.

For those who want their portfolio to be tailored to their personal values, such as environmental sustainability2, religious principles, etc. there are a broad array of strategies and securities that can be leveraged to help meet specific needs.

Diligently assessed

News and information flow continues to accelerate and can create market volatility. Traditionally, press releases were distributed at scheduled times and through formalized channels. In recent years however, we see instances where a company announces a new product via an online video network or a comment by a senior leader on a social media platform which causes a dramatic move in the market. As economies are increasingly driven by fast-moving, distributed data, intellectual assets, and services, we feel it is important to frequently and diligently assess the prospects for each investment and their role in the overall portfolio.

Although a precise and prescriptive evaluation of your individual portfolio should be done with the help of an experienced advisor, below is a basic framework that may be helpful in evaluating whether a particular holding belongs in your portfolio:

  • In what circumstances or state of the world could it experience gains?
  • In what circumstances or state of the world could it experience losses?

And for individual securities (companies or issuers):

  • What are the short-term and long-term prospects?
  • What does the competitive environment look like?
  • How durable or resilient are the company’s financials in the event of unforeseen shocks?
  • How does the company’s current valuation compare to peers and the overall market?

In an actively managed product, the portfolio manager is responsible for the ongoing assessment of the holdings. Portfolio managers and their support teams often use sophisticated tools, mathematical models, analyst insights, and interactions with company management to monitor their holdings.

Routinely stress-tested

Even in a world of online shopping before buying a car, the vast majority of purchasers will take a test drive. It gives the buyer a chance to get a feel for how the car performs: how rapidly it accelerates, how quickly it brakes, and how easily it handles curves or uneven surfaces. Built on the same platform used by portfolio managers at leading investment companies, our RAPTR® (Risk Analysis and Portfolio Testing Review) can provide a similar ‘test drive’ for your portfolio through different market scenarios such as a U.S. Recession, an Oil Price Shock, or a U.S. Economic Recovery. RAPTR® can illustrate the hypothetical impact of certain scenarios to review your level of comfort with potential economic and market events.

Stress Test Comparison

Stress testing is a simulation technique used on investment portfolios to predict the portfolios reaction to different financial situations. Stress testing is a method of determining how a portfolio may fare during a period of financial crisis but may not reflect the actual performance of the portfolio. The chart below compares the difference of your current portfolio's Market Value ($) before and after a theoretical individual stress event. The parameters used in the stress test are provided on subsequent pages.

Stress Test Comparison

With a better feeling for what could happen, the analysis can provide a gut check for your risk tolerance and help you stay invested even in adverse market conditions. RAPTR offers security-by-security risk statistics and can illustrate the risks of concentrated positions (single investments that make up a large portion of the total portfolio) and help uncover unforeseen risk in smaller positions.

Regularly rebalanced

Since different asset classes and sectors of the market tend to perform distinctly from each other over time, diversification3 can help mitigate the risk that one particular position will have a significant negative impact on the overall portfolio. Large concentrations of investments in one area can create significant downside risk in certain market environments. This doesn’t mean that your portfolio needs allocations to every imaginable “slice” of the investable universe, but owning only one or two asset classes (such as large cap domestic stocks) may mean that you’re taking unnecessary risks or forgoing potential returns.

Due to the differences in risk and return characteristics of asset classes, a portfolio can drift away from its target allocations over time. This drift can inadvertently increase risk, exhibit less consistent returns, and potentially put financial goals in jeopardy. To illustrate this, the chart below depicts an investor that established a “60/40” portfolio consisting of 60% stocks, and 40% bonds at the end of 2010. The portfolio was not recalibrated for the next ten years and as a result, by the first quarter of 2020, the investor held roughly a 75% allocation to stocks.

Portfolio Allocation Shift Over TimePortfolio Allocation Shift Over TimeSource: Wells Fargo Advisors. For illustrative purposes only. Chart depicts a hypothetical starting portfolio consisting of 60% S&P 500 Index, 40% Bloomberg Barclays U.S. Aggregate Bond Index and is assumed not to be rebalanced throughout the measurement period beginning December 31, 2010 through March 31, 2020. Indexes are not investable securities. See Disclosures section for full index definitions.

Because stocks (even high quality ones) tend to be more volatile than bonds, the investor who did not rebalance their portfolio ended the period in a potentially riskier position during increased Coronavirus-related market volatility.

Although there is no one specific rebalancing methodology that works for every portfolio, there are a number of guidelines that provide investment discipline you can follow:

  • Calendar rebalancing: Reallocating to target portfolio weights on a periodic basis – for example, quarterly, semi-annually, or annually. Many investment professionals consider a schedule of at least every 12 months to be reasonable.
  • Percent-range rebalancing: Reallocate to target portfolio weights using thresholds representing the percentage deviation from target values – for example, if the target allocation to stocks is 60%, and the allowed deviation range is +/- 5% from the target, then a rebalance would trigger if the portfolio allocation to stocks drifted up to 65% or down to 55% of the total portfolio.

Portfolio rebalancing may involve tax consequences for some investors so it is recommended to work with your Financial Advisor and tax professional to find the right rebalancing methodology and cadence for you.

1 2018 PCG Spring Client Listening Program Survey

2 Sustainable investing focuses on companies that demonstrate adherence to environmental, social, and governance principles, among other values. There is no assurance that social impact investing can be an effective strategy under all market conditions. Different investment styles tend to shift in and out of favor. In addition, a strategy’s social policy could cause it to forgo opportunities to gain exposure to certain industries, companies, sectors, or regions of the economy which could cause it to underperform similar portfolios that do not have a social policy.

3 Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.

Index Definitions

S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.

Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.

Index return information is provided for illustrative purposes only. Index returns do not represent investment returns or the results of actual trading nor are they forecasts of expected gains or losses a fund might experience. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results.

IMPORTANT: The projections or other information generated by Envision regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Results may vary with each use and over time. This information is made available with the understanding that Wells Fargo Advisors and its affiliates are not engaged in rendering legal, accounting, or tax advice.

Envision® Methodology: Based on accepted statistical methods, the Envision tool uses a simulation model to test your Ideal, Acceptable and Recommended Investment Plans. The simulation model uses assumptions about inflation, financial market returns and the relationships among these variables. These assumptions were derived from analysis of historical data. Using Monte Carlo simulation, the Envision tool simulates 1,000 different potential outcomes over a lifetime of investing varying historical risk, return, and correlation amongst the assets. Some of these scenarios will assume strong financial market returns, similar to the best periods of history for investors. Others will be similar to the worst periods in investing history. Most scenarios will fall somewhere in between. Elements of the Envision presentations and simulation results are under license from Wealthcare Capital Management LLC. © 2003-2019 Wealthcare Capital Management LLC. All Rights Reserved. Wealthcare Capital Management LLC is a separate entity and is not directly affiliated with Wells Fargo Advisors.

Wells Fargo Advisors is registered with the U.S. Securities Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.

Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company.