Block Woman looks at a jumbled pile of multi-colored puzzle pieces.

As much as I think most of investing is boring (and should be), I really enjoy the puzzle of what to do when I first start working with a client’s existing investment portfolio. And how I work through that puzzle might help you evaluate and improve your own investment portfolio.

If a new client comes to us with just a bunch of cash (which happens kinda frequently in tech!), then we can put that cash directly into the target portfolio that we design with them (the specific funds we use, in the specific balance we have agreed to), following our investment beliefs. Easy peasy. No taxes to think about. No sticky decisions to make.

Sometimes, however, clients come to us with existing investments. Maybe they have been investing for themselves at Schwab or Betterment or Robinhood. Or they’ve inherited some investments and kept them. Or they have been working with a different financial advisor.

So, if instead of $1M in cash, a client has a $1M investment portfolio. What do we do with those investments? How do we (or can we?) help a client improve their portfolio?

Below is how we generally approach evaluating and hopefully improving the portfolio. Please note, as the saying goes, that this is not investment advice. This is simply a description of our thought process for working through a client’s portfolio.  #ymmv and all that.

One last note: Investing has a bewildering amount of nuance, even if you are committed to keeping it simple. I avoid much of the nuance here (ex. wash sales). I do believe, however, that if you get the big questions right, it makes it more okay to get the nuance wrong.

One Idea: Sell Everything and Start from Scratch

Well, it certainly has the appeal of simplicity.

This would put us right back into the position of starting with a bunch of dollar bills. 

And if all the investments are inside IRAs, sure, we can do that! There are no tax effects from selling investments inside an IRA.  (There can be other costs of selling, like transaction fees. But in my experience, there is rarely a large cost associated with selling inside an IRA, at least, with “normal” investments like stocks and mutual funds and ETFs.)

By contrast, if you have any investments in a taxable account, you risk racking up an unnecessary tax bill by selling. So…probably not a great idea to just blithely wipe the slate clean.

Another Idea: Review Each Individual Investment, and How It Fits Into the Portfolio’s Strategy

In taxable accounts, we look at each individual investment and make a decision one by one, on their own merits and on their merits as part of the larger investment strategy.

For example, say your portfolio is all US stocks. Let’s even say they’re great stocks. But if we’ve decided that the portfolio needs some international stocks and some bonds, some of those US stocks are gonna have to go, to free up some money to buy international stocks and bonds.

I start with this question:

Does the investment have a loss or gain?

Has it lost or gained value since you bought—or otherwise acquired (ex., RSU vest, option exercise)—it?

If it’s a loss, and it’s not an investment we’d normally choose for a client, we can more easily sell it (no tax bill). Then we’re back to starting with cash. (If it’s an investment we would normally choose, then maybe we can tax-loss harvest it to get some tax juju but also keep the exposure to the markets that investment gave us.)

If it’s a gain, then the decisions start to get a bit harder, because there are taxes involved.

If it’s a gain, I then ask myself these questions:

How much of the portfolio does the investment make up?

If it makes up less than 5% (somewhat arbitrary) of the total portfolio, then the decision matters less because its impact on the portfolio is smaller.

How simple do you want to make the portfolio?

I think a proper portfolio can be easily accomplished with five-ish funds. (I’d even believe three. Or, inside only a 401(k), one: a target-date retirement fund.) You might reasonably end up with more than that because of tax-loss harvesting (some of that “nuance” I mentioned) or because of investments you’ve acquired in the past that have grown in value and therefore you don’t want to sell. 

But it can get a little bonkers.

I’ve especially seen this with clients who come from the big financial services companies like Morgan Stanley or who inherit investments from parents who were at such places. I’m talking 20+ funds or even more individual stocks in each account. There’s just no damn reason for that. Mmm, let me rephrase: there’s just no good-for-the-client reason for that.

A simple portfolio is easier to understand and manage. The more attached you are to this idea, the more likely you are to sell, even at a gain.

Can you donate the investment instead?

If you’re already charitably inclined, and you have an investment that has grown a lot in value (measured by %, usually), then donate it instead of donating cash! You get a simpler portfolio and the feeling of being a Tax Genius.

Is this a reasonable investment for you to own, given the investment strategy that you’re trying to implement?

I evaluate reasonableness in part along the lines of cost. Some funds are very cheap; some funds are very expensive. Cost is also one of the few things you can actually control about your investments.

Let’s say you have $100k in a fund that costs you 1% per year. That costs you $1000/year. A fund that costs you 0.05% per year costs you $50/year. Over 30 years—which is a reasonable time frame to consider if you’re, say, 40—that’s a difference of over $28,000 (and that’s just the simplest, most conservative of arithmetic). It’s possible that selling the investment and paying the taxes on the gains will still cost less over time than the cost of owning the investment.

I also think about whether the investment can be used as part of your investment strategy. At Flow, our investment strategies are broadly diversified and passive. (Your investment strategy might differ.) In this example, using Flow’s investment strategy, if your investment is a broad US market index fund that is similar to the one we’d usually use in a client’s portfolio, then probably keep it! If it’s a triple leveraged energy sector fund, probably sell it because, taxable gains or not, it’s not the right investment for that strategy.

At the end of a process that looks more or less like what I’ve described above, we end up marking all of our clients’ existing investments, in taxable accounts, as one of the following:

  1. Sell
  2. Keep
  3. Donate (if you’re so inclined) 

My overarching goal for a client is to arrive at a simple, broadly diversified, low-cost portfolio, while “touching” the portfolio as little as possible. (“Touching” a portfolio generally reduces returns by incurring taxes, incurring transaction fees, and moving in and out of the market at the wrong times. There’s even a fun saying about this: Your portfolio is like a bar of soap. The more you touch it, the less there is.) Sometimes these mandates are in conflict, and I have to find a (perhaps arbitrary) balance.

To paraphrase an investment advisor I admire, I’m aiming not for a “perfect” portfolio, but for a “perfectly fine” one: A portfolio that will fund the life goals that are the whole point of all this work.

Do you want to work with a financial planner who takes intentional, strategy-driven care of your investments? Reach out and schedule a free consultation or send us an email.

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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

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