Some advisers may not have your best interests at heart when they advise you to check your investments at least once a year.
I’m always suspicious when I read someone saying: “You must check your investments at least once a year.”
I get even more suspicious if I see that the person giving the advice is a financial adviser.
I’m suspicious because I reckon some advisers may push for annual investment reviews for the wrong reason. I fear they want to book up annual appointments with their clients so they can flog them a new batch of financial products. Especially investment products.
When it comes to investments, most financial advisers generate their income by being paid commission from the fund management companies. The adviser receives a big chunk of the one-off ‘initial charge’ when the client makes the investment. In following years, the adviser will receive a smaller ‘trail commission’ until the client sells the investment.
Because the initial charge is larger than the trail commission, the adviser has an incentive to recommend that the client sell out of one fund and invest in another. This is known as ‘churn’ and is often a dumb move. If you want to get the best return on your investments, it’s essential that you keep charges as low as possible. If you churn your investments year-after-year, you’ll be enriching the financial services industry rather than yourself.
And the ‘churning’ doesn’t stop there. Many fund managers are constantly buying and selling shares in their funds in a desperate attempt to deliver high performance. Back in 2008/2009, the average ‘churn rate’ for UK unit trusts was 90%.
Before I go any further I should stress that I know that there are many good financial advisers out there. Just because advisers have an incentive to churn their clients’ portfolios too quickly doesn’t mean that they all do so.
I should also add that the regulations for Independent Financial Advisers will change in 2013. Advisers will no longer be able to make money from commission. They’ll have to charge upfront fees from the client which means that the problem I’ve outlined is a temporary one. But the worry is that advisers will be all the keener to churn clients’ portfolios and earn commission while they still can.
Good reasons to review
In spite of what I’ve said so far, there are some good reasons to review your investment portfolio regularly. Let’s go through the main ones:
1. Your goals and circumstances may have changed
When you design a financial plan, it’s crucial you figure out what your goals and needs are. However, these goals can change. And if your goals change, you may need to rejig your portfolio of savings and investments.
For example, you might have been young and single two years ago. All your saving was focused on building a pension pot for your retirement. Now, to your surprise, you’re about to have a baby. This means you need to focus more on saving for the short-term. You may want to move money out of the stock market and into a savings account.
Other changes in circumstances could include marriage, divorce, redundancy, illness or becoming self-employed.
2. Your attitudes to risk may have changed
When you’re 25, you can afford to take a fair bit of risk. If one of your investments goes badly wrong, you’re young enough to make up the lost ground before you retire. But when you’re older, taking big risks makes less sense.
So, as a general rule of thumb, it makes sense to gradually move your money out of the stock market and into cash or bonds as you get older.
3. Get the right weightings
When you set up your investment portfolio, you might have put 10% of your money into funds that invest in emerging markets such as China and India. If those funds did really well and outperformed your other investments, they might comprise 30% of your portfolio after a few years.
You might then think that such heavy exposure to emerging markets was too risky and you’d have to rebalance your portfolio. To do that, you’d have to sell two thirds of your emerging market funds and invest them elsewhere.
4. A fund manager has left the fund
You may have chosen to invest in a fund because the investment decisions were made by a ‘star’ fund manager. If she then leaves the fund, you may think it’s time to sell out from that fund.
Fair enough, but the danger is that if you sell out every time a manager leaves a fund, you may well end up churning too much. This is one of the many reasons I normally prefer to invest in index tracker funds rather than active funds with expensive managers. If a fund doesn’t employ an expensive manager and instead just tracks the movements of a particular index, you’ll pay lower charges and you won’t have to churn your investment when a star manager leaves.
Final answer
So what’s my final answer? Do you need to review your investments every year?
Perhaps not every year, but I certainly think you need to review your investments regularly. Once every two years is the maximum. Just be careful if someone advises you to switch your investments. If it's for a good reason, then go for it, but if it's just so that an adviser can earn commission, leave well alone.
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