How to Evaluate an Investment Portfolio You Inherit

The following is adapted from Inheriting Chaos with Compassion.

Of all the things you can inherit after a loved one passes away, an investment portfolio is one of the trickiest, especially if you’re not an experienced investor. Understandably, an investment portfolio is designed to help someone achieve their financial goals, and when we inherit that portfolio, those assets may not support our goals.

That’s what happened with a client of mine named Bethany, who inherited her aunt’s portfolio after she passed. Bethany’s aunt was like many older people who use a singular investment strategy; in Bethany’s case, her aunt held all of her stock in a single hotel chain. For people who came out of the Great Depression with a deep distrust of banks and the stock market, if you were going to invest in a company’s stock, you only did so if you trusted the company whose stock you were buying.

That often meant investing in big companies with public visibility, like Ford, or buying the stock of the company they worked for because they were familiar with the company’s operations and its growth. Another guiding mentality of the time was to look for the companies that would pay the largest dividends and create seemingly reliable income.

But as dividends plummeted in the wake of the Great Recession, we can see strategies that worked in past markets may not work in the current financial climate.

Similarly, investment strategies that supported the goals of your loved one may not support your vision for the future. The key is to regularly evaluate your investment portfolio and adjust it based on how it’s performing for you.

Let’s look at some things to consider when evaluating an investment portfolio.

A Balanced Portfolio

The first indicator a financial advisor looks at in a portfolio is the overall mix of stocks and bonds. A generic starting point is a 60/40 ratio of stocks to bonds, but the particulars of this mix will be different for each individual, depending on their personal goals and their risk tolerance. To determine what that should look like, we ask a lot of questions about the investments they’ve made in the past and their future needs:

• When do you expect to need the money you’re investing?
• How comfortable are you with seeing stock values fluctuate?
• How much have you saved?
• How much time do you have for your money to grow?

It’s vital to place the client’s needs in the context of their financial history and future plans, so we can see how they’ll need their investments to perform for the future.

For example, if a client knows they’ll need to cash out their investments within five years, stocks aren’t the best investment vehicle for them. If there’s a short-term downturn in the market, those investments will need time to recover and grow.

On the other hand, if a client has plenty of time and a small amount of savings, we may want to consider stretching their comfort zone with a larger proportion of stocks to maximize their growth. Again, we consider each client’s comfort level with their risk.

Put simply, risk tolerance is your ability to sleep at night when the markets go down. It’s never a good idea to sell into a down market, and you’ll need to balance that rule against the worry you might feel as you weather a dip in your investment values.

Market Corrections

Fluctuations in the stock market are caused by the collective moves of market participants buying and selling their stocks. These shifts between buyers and sellers determine the fair prices of stocks. When stock prices creep higher than the underlying value of the corporation, market participants begin to sell, and this can result in a “market correction” to bring the price back down.

You can’t prevent a market correction, but you can prevent a portfolio from experiencing more of a hit than necessary. In assessing the mix of stocks and bonds in a portfolio, it’s important to account for how much time you’ll have before you need to take money out of the market to spend. If you have a high percentage of stock in your portfolio when you begin taking distributions, you become vulnerable to fluctuations in the market.

If you need to take money out of the market during a downturn, you do long-term damage to your portfolio. Not only have you temporarily lost value in the stocks you liquidate, but you also lose the opportunity to grow that money.

When the markets do turn around, you have a lower base of investments to grow. Historically, stock prices recover from market corrections in three years or less.

As you can see, you want to avoid taking distributions from investments in the middle of a market correction, so it’s important to balance your portfolio based on how soon you may need money back out of the market. Stocks are the best vehicle for growth in a portfolio, and a mix of bonds are used to mitigate the volatility of the markets, particularly as you take distributions from your investments.

Another tool for weathering market corrections is to invest in international markets.

International Markets

Markets across the world do not usually move in the same direction at the same time. As you construct a strong investment portfolio, you want to increase the probability that the asset classes you own are increasing in value. International markets can be a component of this balance because of their ability to even out US market swings.

The first decade of the 2000s is nicknamed “the lost decade” because the total return of the S&P 500 (an index of the 500 largest companies in the US) during that time was slightly less than zero. However, international stocks did quite well in this same time period, and people who had certain international stocks in their portfolios saw growth of 6 or 7 percent. It’s impossible to predict when these fluctuations will happen, and for that reason, it’s prudent to own profitable economic activity all over the world.

US markets break down to large, medium, and small sizes, and similarly, international markets are broken into two categories: developed and emerging (each of which are also further subdivided into large, medium, and small market sizes).

Developed international markets include companies in countries with developed markets and regulations, such as Canada, Germany, and Japan. These markets have perceived stability, and often experience less fluctuation than emerging markets.

Emerging markets include companies in countries with a history of less-reliable markets and economies. The big four emerging markets are Brazil, Russia, India, and China, who are all relatively new to the public stock market.

The interaction between governments and companies influences performance in a given market, and emerging markets tend to have interesting relationships between government and business. For example, many companies in China are still state controlled, and a lack of free market participation informs stock prices. Reporting requirements also vary in international markets, which affects their stability.

When emerging markets move, they tend to move big. Emerging economies tend to be driven by commodities and exports, and this affects—and often benefits—their performance. Emerging markets are the most volatile asset class, but because these markets tend to react to different influences and at different times than US markets, they can have a stabilizing effect on a portfolio that increases returns.

Emerging markets don’t always go against the grain of US markets, but they can provide needed diversity. Mixing different asset classes can counterbalance a portfolio, so that when one asset class goes down, another might be going up.

It’s important to evaluate how each investment affects the overall mix of a portfolio and how these markets offset each other. With careful choices, you can dial in the amounts of each market that will maximize growth while matching your preferred risk level.

Diversifying Inheritance

When you inherit a portfolio from a loved one, it’s likely that the mix of assets that served them isn’t in line with your own goals and needs. Due to the market trends we’ve discussed, it is common for people of older generations to hold stock portfolios that contain a heavy mix of stocks from large US companies.

This can be a good strategy during certain market trends—historically, large US companies do very well—but market conditions shift over time.

A balanced portfolio takes into account the individual’s needs for return, their tolerance for risk, and the current market conditions. With a step up in cost basis, inheriting a portfolio presents a beautiful opportunity to diversify.

When you create an investment mix that’s nicely balanced for your needs, it increases your probability of success in meeting your future financial goals.

More important than the value of the investments themselves is whether those investments support the life you want to live. In Bethany’s case, her aunt’s legacy opened up new possibilities for the dreams Bethany could pursue.

We sold everything in the portfolio that did not fit with Bethany’s strategy, and we invested those assets according to her goals. The possibilities of what she could do with her life shifted with this inheritance. Bethany and her husband began looking to buy a new house. Beyond that, the inheritance gave her more freedom to choose how and when she wanted to work, which opened up her leisure time.

As you evaluate the portfolio you inherit, consider some of the factors mentioned in this article to see how the assets in that portfolio can serve your financial goals.

For more advice on evaluating an investment portfolio, you can find Inheriting Chaos with Compassion on Amazon.

Jennifer Luzzatto is a Chartered Financial Analyst®, a Certified Financial Planner®, and a NAPFA registered financial advisor. She began her career in financial services thirty years ago as a fixed-income trader in a regional brokerage firm and went on to manage personal trust accounts, institutional portfolios, and a municipal bond mutual fund at a commercial bank. In 1999, she founded Summit Financial Partners, transitioning from banking to financial planning and investment advisory services. Jennifer holds a BA in Psychology and an MBA from the University of Richmond. She lives in Richmond, Virginia, with her daughter and their dog.

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