Do You Know What Questions To Ask For Your “Investment Audit?”

I recently met with a new client (let’s call him “Steve” – not his real name) to do an audit of his investments as well as the investments of his wife “Holly.”  They have been using an internationally known “name brand” wealth management company for over 20 years.  The audit showed that several accounts are doing quite well against an appropriate benchmark.  However, three other accounts are only doing so-so, and three other accounts, well … let’s just say that there is the same amount of money in the account as when they started out.  So, compared to inflation, their returns on these three accounts have actually been negative.

Although analyzing the client’s investment returns is an important first step, this should only be a starting point for your audit.  So, what else should you ask about … you ask??? Here are nine questions you will want to ask in your audit.

By the way, if you would like an audit done for no charge, we will do that for the first ten respondees.  Just reference this article and enjoy a free audit of your investments.

1) Risk Profile Assessment

The Risk Profile Assessment helps me determine what types of investments are best suited to the client.  If you have not completed a Risk Profile Assessment recently, one can be completed within 10 -15 minutes by answering a series of questions.  The Risk Assessment Profile helps me determine whether your investments are in harmony with your risk tolerance.  Our questionnaire provides us with six different investment profiles ranging from the most risk-adverse investor (a “capital preservation” client) and then up through the investor spectrum to the last category, that being an “aggressive growth” investor.  If you are a couple, there is almost always a difference in investor classification … which then needs to be addressed, and a compromise worked out to address these differences.  One last point, you might have a different investor classification for different buckets of money.  For example, your retirement account(s) might have a different risk profile than your after-tax investment account.  So … what is your risk profile (and your partner’s?)

2) Investment Policy Statement

The second document I look for is called an Investment Policy Statement (IPS).  Do you have one?  If not, how do you know what types of investments would be appropriate for you?  How does your advisor know?  If you do not have an IPS, one should be created.  Creating an IPS will take more work than a Risk Profile Assessment but the extra time is well worth the effort.  An IPS formalizes your investment rules and strategies and is like having guard rails on a bridge.  More detailed information about the components of an IPS may be found in my February 2016 newsletter article here:  So, do you have an IPS and if so, what are appropriate (and inappropriate) investments for your portfolio?

3) Are the Investments a Good Match?

After looking at the Risk Assessment Profile and IPS, I then review the client’s investments to see if they are a good match.  It is the rare situation where I find that the client’s investments are properly matched with their risk tolerance.  For example, in Steve and Holly’s case, there was a “disconnect.”  Holly’s account was invested in such a way that the “volatility index” … how much “up and down” … was much higher than what her risk tolerance level suggested would be appropriate for her.  Steve’s was actually a little lower than what his risk tolerance score indicated would be appropriate for him.  Why does this matter?  It means that Holly’s account will likely have a lot higher-highs and lower-lows than she is comfortable with month-in and month-out.  And, with Steve’s portfolio’s risk tolerance level being lower than what his “risk appetite” can handle, the returns will likely be lower over time than what we would expect.  The higher the volatility (the ups and downs), the higher the return we would expect over time.  So, I would expect that Steve’s portfolio would under-perform what it could potentially do, again, over time.  How do your current investments match up to your actual risk profile and Investment Policy Statement?

4) Diversification

My next area of focus is to determine whether there is a lack of diversification in the overall investment strategy.  The five main categories of investment classes are: cash and its equivalent, fixed income investments, stock ownership in businesses, real estate investments (your home does not count), and commodities.  Each asset class has its own benefits and drawbacks.  The specific asset allocation of each client’s portfolio will vary, depending on a number of factors, including their risk tolerance, needs, and resources.  What is the make-up of your portfolio?  How much do you have in each of these five buckets?  (Pssst – most don’t have anything in the 4th and 5th asset classes – and you should!)

5) Non-Correlated Assets

Volatility in your investment portfolio can be minimized by selecting several different non-correlated assets.  What does that mean?  The goal of selecting non-correlated assets is to (at least in theory) avoid the large amount of turbulence that can occur when you hold only one type of asset class.  Although your gains may not be as high when investing in non-correlated assets, the lows will typically not be as low as when you are holding only one type of investment.   Since you are eliminating or reducing the potential for large negative returns, over time, you should see greater, overall returns.  How much and what percentage of your investment portfolio is in non-correlated investments?

6) Underperforming Assets

I then investigate whether the client has any underperforming assets.  Underperforming assets can include investments that have excessive advisory or load expenses; these excessive expenses can consume large gains and leave the client with underperforming, overall returns.  Underperforming assets can also include investments that do not achieve the same gains as other similarly situated investments.  There are several measuring ratios we use – beta and alpha, among others.  We use a benchmark index that is commensurate to your risk profile and see how much the portfolio goes up and down as compared to the measuring benchmark index.  The lower the ratio (i.e., the actual portfolio’s projected volatility over the index’s historic volatility), the better.  This ratio is called “beta.”  And, the higher the portfolio’s projected return divided by the index’s historic return, the better (this is referred to as “alpha.”)  How does your current portfolio measure up in their beta and alpha ratios versus the proposed portfolio?

7) Retirement Needs

Three key questions to answer as regards retirement are:

  • How much?  
  • How soon?  
  • How long?

That is, how much income do you want or will you need in retirement?  When do you plan to retire?  How long do you expect to live (and it is likely longer than you think!)  The blended male/female life expectancy for a 70 year old today is … 97.4!  Half are dead, but half are still alive at that age!  Will your assets last that long?  I generally recommend that you allocate your assets in such a way that your retirement assets will be held in three separate “buckets,” which can be draw upon as needed.  What are the buckets?

  • Short-term: This is the first bucket. It should have liquid assets that will sustain you for 3-5 years.  These investments should have little to no volatility.  The rate of return is not as important as knowing that the value of the assets will not potentially go down unexpectedly.  You have a broom in your closet; do you care about the rate of return?  No, because it is the utility of the broom that is most important.  The same is true here.  Annuities or very conservative income generating assets are frequently used in this bucket for those expenses that are fixed and recurring, and where you want a specific amount of monthly income for a certain number of years or to sustain your current lifestyle.
  • Medium-term: This is the second bucket. When deciding what goes into this bucket, your time horizon should be somewhere between 6 and 15 years.  Again, income investments can be great investments to hold in this bucket, and should include investments in the U.S., and also internationally for diversification.  As well, this might include real estate investments that generate income with a 5-10 year (or perhaps longer) holding period before a liquidity event.  Some private placement real estate projects I am seeing are paying a 9% preferred return, with a 1-1.5% projected annual increase until liquidation sometime in the 4th or 5th  If there is a liquidity event, those proceeds can be poured over into bucket #1 to replenish those assets. So, while this is an income bucket, it is also a bucket where we can expect long-term capital gains.
  • Long-term: This is the last bucket. This is the most volatile bucket because it seeks to grow your overall portfolio.  It is not expected that the assets in this bucket will be accessed for upwards of 15 years.  Because of the long-term nature of this bucket, you can be more aggressive in your investment choices.  Any short-term losses will likely recover over time (assuming you don’t panic and pull out prematurely!)

When you retire and are ready to take money out of your buckets, it is best to employ the “sequencing of income” strategy.  Take your income first from bucket #1.  As you move through retirement, slowly move your assets from bucket to bucket, moving unused income and proceeds from any sales in bucket #2 into bucket #1.  Buy more liquid (and less volatile and safer) assets that continue to keep bucket #1 funded for your current needs.  As you move assets from bucket #2 to #1, make sure to keep bucket #2 filled.  You can do this by periodically taking money “off the table” when assets have appreciated over time in bucket #3, and then put the profits you are harvesting and migrate that to bucket #2.  Do you have your buckets identified and filled up or are you in the process of filling them up?

8) Inflation

Inflation estimates should also be considered since the purchasing power of a dollar in the future may be much less than it is today.  From 1913 until 2013, the inflation rate has averaged 3.22%.  But since 1990, however, it has been 3% or less.  In 2015, for example, the inflation rate was only 0.12%!  What rate of inflation are you using when making your calculations?  And, have you factored that inflation rate over the much longer life expectancy you will likely achieve (see point #7 above).

9) Tax Consequences

And last but not least, tax consequences need to be factored into your investment planning.  Any taxes you pay on investments need to be deducted so that you know what the net income of the investments actually is.  There are a number of ways in which investments can be harbored in an environment that is non-taxable or up to 99% tax-free.  Are you taking advantage of this?  Do you know what all your options are?

So … we have looked at nine primary questions to ask in gauging whether your investments are working as hard as they can.  Gee … having a systematic process to follow in maximizing returns.

Imagine That™”!


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Written by R. J. Kelly – August 2016

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