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Sorry, You Probably Don't Have a Portfolio Emergency

What ails many portfolios--and what can fix them--is actually pretty mundane.

Editor's note: A version of this article appeared on May 7, 2017.

A friend recently sent me an email to tell me he was worried about his portfolio.

He had had a free consultation with an "advisor" onsite at his workplace, and that person had spotted some problems. The low-cost target-date 2035 fund that he had invested in through his 401(k) (that I had recommended) was way too conservative, for one thing. Meanwhile, the advisor thought my friend's rollover IRA, parked in an S&P 500 index fund, completely missed the boat because it didn't include small caps. The advisor's solution? A variable annuity.

My friend was freaked out. Did he truly have a portfolio emergency on his hands, as the advisor had suggested? Would I be willing to look everything over and give him a second opinion?

I would, and I did. He sent me his statements depicting his recent balances and allocations. His portfolio was a model of simplicity--the target-date fund in his 401(k), as well as the index tracker in his IRA. I could see the advisor's point about adding a dash of small caps to the IRA; that could be readily achieved by swapping in a total stock market index in place of the S&P 500 fund. But a portfolio emergency? I just didn't see it.

I did see a bigger problem, though. My friend simply hasn't saved enough for retirement. He's in his late 40s and single; together, his IRA and 401(k) account balances add up to about $250,000. Nor does he have enough in liquid assets given that he works as an independent contractor. He makes a good salary when he's employed, but he has frequent lulls in his income; his liquid reserves total just $20,000, and he doesn't have disability insurance.

Where the advisor had spotted an investing problem, I saw a much more mundane issue: a savings shortfall. What ailed my friend's financial plan wasn't going to be fixed by bumping up his weighting in small caps, or getting out of the 2035 target-date fund because of its 20% bond position. It most certainly wasn't going to be rectified by steering the money into a high-cost variable annuity.

Instead, the real problem was that in order to avoid a meaningful reduction of his income in retirement, my friend needs to find a way to step up his savings and keep it up. He needs to enlarge both his retirement-account balances as well as his liquid reserves. He might need to entertain working past age 65.

When we discussed it, my friend acknowledged that the advisor had also told him to target a higher savings rate. I wasn't there, so I can't know for sure how that discussion went down, but it's highly possible that the advisor soft-pedaled that difficult message in favor of pushing portfolio fixes (and product). It's also likely that my friend, in search of a noninvasive solution for problems in his financial plan, zoned out during the discussion of saving more; he latched onto the idea of changing up his portfolio allocations instead.

My friend's experience isn't unique. People often look to their portfolios and their investment selections to do the heavy lifting for their financial plans. The main reason is obvious: Watching your money grow on its own is inherently more fun than reducing spending in order to save. Some investment advisors--especially those with products to sell--are all too eager to pander to the notion that investors won't have to sacrifice much; their investment portfolios can work their magic. It's also true that many investors--me included--began investing in earnest in an era when the market really could work magic. It's hard to believe today, but the S&P 500 actually returned more than 20% in each year between 1995 and 1999, an annualized return of nearly 29% over that five-year period. At that astounding rate, investors quadrupled their money in the space of five years without adding another dollar to their accounts.

Of course, such a stretch isn't likely to be repeated during our investment lifetimes. And if on the odd chance it is, it's likely to be followed by some gut-wrenching losses. (If you'll recall, stocks promptly lost more than half of their value between 2000 and 2002.) In light of stock's current, long-running rally, most sober-minded market experts believe that investors should employ muted return expectations for stocks and bonds over the next decade. And muted return expectations mean that lifestyle adjustments--spending less, saving more, working longer, delaying Social Security--will be a much bigger determinant of the success or failure of investors' plans than will their investment performance.

That's not to say that asset allocation and investment selection don't matter--they absolutely do. Minding investment and tax costs is important, too. But as my financial priorities pyramid shows, no amount of investment acumen can make up for a plan that didn't begin with articulating and quantifying a financial goal, then saving an appropriate amount for it. Relying on those levers that you control, rather than the market, has another key benefit. While saving more and working longer may not be fun, their contribution to your portfolio is guaranteed, an assurance you simply don't have by investing in the market.

My friend's experience is also an illustration of the importance of knowing the difference between financial-planning advice and investment advice. The former is holistic and takes into account your total household balance sheet; a good financial plan can help you set your savings rate (and find money to save, period), decide whether to pay down debt or invest in the market, and prioritize competing financial goals. Investment advice, while extremely valuable, isn't as encompassing, and small investors can gain access to it through inexpensive off-the-shelf solutions like target-date funds and robo-advice. The financial-planning piece isn't as sexy, for sure, but it's hard to succeed as an investor without it.

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