The end of the year is the perfect time to reflect on your portfolio. But sometimes, that can lead to anxiety if there is a rift between where your portfolio is and where you want it to be.
Instead of trying to trade your way out of discomfort, a better approach is to engage in exercises that can help set the stage for compounding your wealth over time.
Here are investment portfolio actions worth taking before the end of the year.
Image source: Getty Images.
Conduct a portfolio review
Investing in the art of putting capital to work in quality companies, identifying risks that can derail an investment thesis, and sticking with winning companies over time -- these are all part of a portfolio review. Having an investment thesis for each asset you own is paramount. Some can be short, whereas others can be long. But it's essential to know what a company does, what it is trying to do, and why you believe it is worth putting your hard-earned money into.
You can also make investment theses for companies you don't own but are high on your watchlist so that you can have the conviction to buy them when it makes sense for you to do so.
As an example, here's the essence of my investment thesis on Microsoft (MSFT -1.73%):
Microsoft is an industry-leading company with exposure to several end markets. It has evolved from mediocre sales growth and weak margins to a high-margin cash cow -- largely thanks to the build-out of Microsoft Cloud and product upgrades of existing software. Microsoft is monetizing artificial intelligence (AI) throughout its product suite, from Microsoft 365 to GitHub, Azure, and more. Microsoft is well diversified across hardware and software. It owns LinkedIn and has a powerful place in gaming with Xbox and Activision Blizzard. Microsoft generates plenty of excess earnings to pay a growing dividend and repurchase more than enough stock to offset stock-based compensation, which grows earnings per share by decreasing the outstanding share count and making Microsoft a better value.
Because Microsoft has more cash, cash equivalents, and marketable securities than debt on its balance sheet, it is well positioned to endure an industrywide downturn and even take market share or make timely acquisitions. Microsoft's 36.1 price-to-earnings (P/E) ratio is above its historical levels, putting pressure on the company to deliver outsized growth or risk facing a sell-off. But long term, Microsoft has plenty of levers to pull for growing earnings, making it worth holding even if the stock price goes down in the near term.
Aligning allocation with risk tolerance
Another mistake investors can make is losing sight of their portfolio allocation. Technically, a portfolio's allocation changes anytime the market is open with movements in stock prices. But the bigger picture is to identify when there is a substantial change in your portfolio.
For example, let's say you invested 10% of a $10,000 portfolio in Nvidia (NVDA -2.09%) and 10% into Meta Platforms (META -0.59%) a year ago. Nvidia is up 218.9% during that period, while Meta is up 91.8%. Let's assume the other 80% of the portfolio performed in lockstep with the S&P 500 (^GSPC -1.11%) and is up 33.2% during that period.Here's a look at how that hypothetical portfolio would change in just one year.
|
Holding |
Starting Value |
Percentage of Portfolio |
Gain |
New Value |
New Percentage of Portfolio |
|---|---|---|---|---|---|
|
Nvidia |
$1,000 |
10% |
218.9% |
$3,189 |
20.2% |
|
Meta Platforms |
$1,000 |
10% |
91.8% |
$1,918 |
12.2% |
|
S&P 500 |
$8,000 |
80% |
33.2% |
$10,656 |
67.6% |
Nvidia now makes up around 20% of the portfolio instead of 10%. And even though the Meta investment nearly doubled, its percentage of the portfolio actually didn't change that much because it was offset by outsized gains from Nvidia and good gains from the S&P 500.
If you look at how your allocation has evolved and are ok with it, then you may not need to do anything. But you could also find you are way more allocated toward a certain company, theme, or sector than you thought. The knee-jerk reaction may be to sell out of those winners and rebalance into other names. But that strategy can result in regret if you sell a stock just because it went up. It's better to have a clear reason for selling a stock.
The best approach for addressing an uncomfortable allocation is to put new capital to work into other high-conviction areas. For example, if someone felt their portfolio is too concentrated in megacap, tech-focused growth companies, they could consider investing in safe dividend stocks, growth companies from other sectors, or a diversified exchange-traded fund (ETF) like the Vanguard Mega Cap Value ETF.
Suppose you are in the capital-preservation phase of your financial journey and no longer regularly putting new capital to work in the market. In that case, you may need to take the necessary actions to balance risk and potential reward by investing in companies that are valued based on what they are doing today rather than their potential growth. The next lesson applies to investors in the capital-accumulation phase, so if you're in the preservation stage, feel free to skip it.
Set savings and investment goals for 2025
It is just as important to set clear savings goals for 2025 as it is to update your watchlist of stocks you want to buy.
Simple math shows us that it is far better to be a great saver and a mediocre investor than a bad saver and an exceptional investor.
As an example, let's say two people start with $20,000 and have a 10-year time horizon. Person A earns an average annual return of 10% a year and additionally saves $5,000 per year that goes into the same investment portfolio. At the end of the 10-year period, they end up with a tidy sum of $131,561.97.
Person B achieves 20% average annual returns but doesn't contribute any savings. Despite returns that rival Warren Buffett's average from 1965 to 2023, they would end up with $123,834.73 after the 10-year period for the same $20,000 originally invested. It's still highly impressive, but if they would have also saved $5,000 per year, they would end up with over $253,000 at the end of the 10-year period.
Position yourself to endure the unexpected
Instead of getting caught up in speculating what the stock market will do in 2025, it is a far better use of time and energy to review what you can control: your investments and savings habits.
Having a firm grip on these factors makes it far easier to filter out the noise and focus on achieving your financial goals. This can be especially helpful when the market is going down and volatility is high.
