You’re thinking about long-term goals: retiring, buying a second home, paying for your children’s college.
You want to optimize your portfolio for the best long-term outcome.
But here’s a problem:
Your financial advisor (if you use one) must answer to the calendar year.
Most people fixate on the value of our portfolios on one particular day — December 31 – as it compares to another particular day, the previous January 1.
As a result, investment advisors often feel enormous pressure at this time of year to do things that are not in the best long-term interests of the portfolio.
This is sometimes called “window dressing.” And it’s dangerous to your long-term portfolio health.
The Problem With the Calendar Year
It makes sense to review the performance of your portfolio over the span of the past twelve months.
But why put such a high priority on portfolio performance from January 1 to December 31? Those dates are arbitrary. It makes just as much sense to measure your portfolio performance from March 17 of one year to March 16 of the following year.
But few people pay attention to any other random separation of 365 days. We’re stuck on January 1 to December 31.
How do investment advisors grapple with that reality?
Like it or not, investment advisors worry about their own careers, just like anybody else. Thus, we have this phenomenon of “window dressing” every December.
Why Window Dressing Can Damage Your Portfolio
Window dressing often involves buying positions in stocks or asset classes that have been particularly strong over the year.
Why? An investment advisor’s performance can be broken into two key components: asset class weightings and actual asset selection.
An asset class can be an industry sector, a geographic region, a market cap range, or any other grouping of similar assets.
Imagine, for example, that technology stocks are the best-performing sector on the S&P 500. An advisor may be tempted to increase her technology weighting before the end of the year. When the annual review comes around in January, she can say that she’s not underweight in that sector.
Likewise, if Intel or Google or IBM has had a particularly strong run compared to other technology stocks, she might be tempted to load up on these names ahead of review time.
But isn’t this all transparently misleading? Yes, it is.
A diligent investor will be able to comb through his annual statements and pinpoint the window dressings for what they are. But not all investors are diligent. Many, in fact, just want to hear the short summary and be done with it.
The advisor can say something like, “SuperTech Inc. rose 21% last year, and you have SuperTech in your portfolio.” If the investor doesn’t push for more context, he might not notice the fact that the advisor added SuperTech on December 21, rather than earlier in its bull run.
Strangely, window dressing sometimes works in the short term. If thousands of investment advisors are all buying SuperTech in December, then the stock will likely enjoy an added burst.
The problem is that in January, SuperTech may experience a sharp correction. Oops.
How to Avoid Window-Dressing
It is hard to escape window dressing. Our brains are wired to care more about certain arbitrary days than others.
Besides, we are going to get annual statements as of December 31, not on March 17.
How can you avoid being mislead by window-dressing?
Encourage your advisor to resist making ill-advised window dressing decisions by treating annual, quarterly, or other periodic reviews for what they should be – signposts on the road towards long-term goals, rather than ends in-and-of themselves.
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