4 Things to Check When Selecting a Portfolio Asset

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Congratulations! You set up your 401(k), brokerage account or investment portfolio and have taken the first step toward planning for your future.

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You probably already are aware of some of the benefits of investing, but perhaps that’s as far as you got. When looking across the vast universe of assets you can choose from, it’s natural to feel overwhelmed.

If you’re not sure how to select the investments in your portfolio, here are four things for you and your advisers to consider when evaluating assets.

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1. Risk/return profile

Harking back to theories about portfolio management, each investment carries its own unique probability of returns and level of risk. You may have heard of the term for this equation, known as the Sharpe Ratio.

Think about it in these terms. Let’s say you’re taking a trip that will be about 500 miles. If you drove the speed limit, let’s say you’d arrive in eight hours. However, I got to the destination in four hours by speeding like crazy.

We both attained the same outcome — to get to our destination — but I took on an extreme amount of risk to get there faster than you. Was it worth the risk of crashing my car or injuring myself?

As they say, there’s no such thing as a free lunch. If you want higher returns, you have to accept the associated higher level of risk. On the flip side, if you can’t stomach the loss of principal, you would be best served by selecting conservative investments.

2. Fees

When it comes to investing, fees are largely unavoidable, but you want to make sure you’re getting your money’s worth.

Mutual funds and exchange-traded funds that are actively managed are usually more expensive. That’s because you have fund managers and analysts conducting research to try to outperform the index. Assuming the mutual fund managers’ strategies work out, the return should outpace the fee. They charge a higher fee to be compensated for the superior returns they are, in theory, providing.

Another thing that can increase fees is the different sectors represented in your portfolio. If you are investing in a more obscure corner of the market — such as emerging markets — that requires more research, more vetting, etc., it likely increases the fees you’re paying. In return, you’re diversifying your portfolio to gain exposure to a largely untapped part of the market.

If you’re an investor who is totally averse to paying fees, you might want to select passive investments. Most — although not all — exchange-traded funds are passively managed and thus less expensive. A few can even be free.

Look across the strategies in your portfolio on a regular basis. If you’re paying higher fees, are they justified in the form of returns?

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3. Liquidity

Some investments require your money to be deposited for a certain period of time. A common example is a certificate of deposit, commonly known as a CD. There are penalties if you want to access the money prior to the maturity date.

This can also be true for investments, such as a private equity fund, a hedge fund or a private real estate fund.

You should look for appropriate payoff for any type of investment that requires your money to be inaccessible for a period of time. However, the reality is that most investors would prefer to have access to their money. If that’s the case for you, it makes sense to choose an investment that has greater liquidity, like a stock or bond.

4. Tax efficiency

When thinking about making an addition or subtraction from your portfolio, you want to consider its impact on your portfolio’s tax efficiency. You should consult with your tax adviser to determine impacts.

For example, exchange-traded funds are known to be very tax-efficient investments, whereas some mutual funds can be less tax efficient because that’s not what they were created for.

Another area would be in fixed income. If you have corporate bonds, they are going to be taxable. On the flip side, municipal bonds provide tax-free income.

It’s common sense, but if you are not cognizant about your portfolio’s tax efficiency, you could receive dividends or capital gains and be surprised when a large tax bill comes your way.

That’s not to say you should only invest in tax-efficient vehicles, but you want to be sure that you’re benefiting in other ways if you are choosing investments that could result in added taxes.

Each investment has its own unique characteristics, both positive and negative. Be sure that when you are evaluating an asset, you are aware of the role it will play in achieving your goals and any potential downsides to owning it.

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The material presented in this article is of a general nature and does not constitute the provision by PNC of investment, legal, tax or accounting advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions expressed are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. You should seek the advice of an investment professional to tailor a financial plan to your particular needs.

Securities are not bank deposits, nor are they backed or guaranteed by PNC or any of its affiliates, and are not issued by, insured by, guaranteed by, or obligations of the FDIC, the Federal Reserve Board, or any government agency. Securities involve investment risks, including possible loss of principal.

Learn more at www.pnc.com.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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As a Vice President and an Investment Market Director in the Southeast market for PNC, Justin Sullivan provides investment leadership in the creation and implementation of investment strategies. Justin also serves as an investment adviser for complex accounts. Justin works with a team of investment advisers, specialists in financial and estate planning, trusts and banking services to help clients achieve their financial objectives.