Why Your Portfolio's Overlap, Bond Markups, and Dividend Yields Must Be Questioned

Once a month, you likely receive a stack of paper or an email from your brokerage house—pages and pages detailing your account holdings. You look through the list of mutual funds (those assets ending in 'X') and ETFs, and a feeling of dread washes over you: complexity.

You're trying to figure out if your portfolio is optimized, but your advisor may be avoiding the three questions that reveal efficiency, cost, and risk.

Today, I'm going to talk about the three numbers your advisor does not want to talk to you about, why they matter, and the specific tools you can use to find the answers yourself. You can take a look at the video version of this content here.

Secret 1: Portfolio Overlap Analysis

The problem I see most often is portfolio splintering. You might start with a simple 60/40 allocation, but over time, you add more managers or funds that end up holding many of the same stocks. This creates unnecessary complexity without actually increasing diversification.

• The Splintering Effect: You may have nine distinct funds trying to capture large, mid, and small cap growth, value, and international markets. You might have two different managers in the same segment (e.g., U.S. Large Cap Equity) because one underperformed, and you hired a second manager with a different strategy.

• The Result: You end up paying two different people to potentially do two opposite things, and your portfolio's performance is the net result of their work. Your final portfolio looks a lot like the market benchmark, but you're paying higher fees for the internal management battle. You are effectively paying for two different breath mints (Managers A and B) that both aim to make your breath smell better, but they don't enhance each other.

How to Check for Overlap (The Solution)

You need tools to see how closely the return streams of your funds move together:

• Fund Overlap Tool (ETF Research Center): This simple tool can show you what percentage of stocks two funds share. The limitation is that many versions only allow you to compare two funds at a time.

• Portfolio Visualizer: A more technical tool where you can input your entire portfolio. Look at the Monthly Correlations section.

  • The Goal: Correlations run from -1 (opposite movement) to 1 (identical movement). If two funds in the same asset class (e.g., two different U.S. Equity mutual funds) show a correlation close to 1, you are likely doubling up and paying redundant fees.

Secret 2: Markup on Your Bond Ladder (The Sneaky Cost)

Bond ladders are excellent tools for retirees. They provide safe, steady, predictable income and protect against sequence of return risk by allowing you to draw cash instead of selling stocks during a market dip. So, what's the secret?

• The Liquidity Problem: Unlike stocks, which have an ocean of liquidity, individual corporate bonds or municipal bonds (which you need for tax-free income) can be less liquid. This is especially true for bonds with lower credit quality or those in smaller state municipal markets.

• The Hidden Markup: Less liquidity means a wider spread in the market. You end up paying a higher price (a "markup") for the bond than the dealer bought it for, and you rarely see this cost disclosed upfront.

How to Check the Markup (The Solution)

You can check whether you got a fair deal using FINRA's Trade Reporting and Compliance Engine (TRACE) website:

1. Go to the FINRA website and find the Fixed Income Data section.

2. Agree to the user agreement, and you will be taken to the TRACE database.

3. You can input the ticker symbol (the nine-digit CUSIP code) for your specific bond.

4. You can then see the prices paid by other market participants for that bond on or near the date you purchased it, revealing whether your price was fair or if there was a high markup.

Secret 3: The Meaningless Dividend Yield

Many retirees believe they can "live off their dividends" and avoid touching their principal, creating the perfect retirement plan. This focus on dividend yield is flawed because a high dividend yield does not guarantee a higher total return.

• Total Return: Your assets' total return is made up of both income (dividends and interest) and equity appreciation. Focusing solely on income ignores the capital appreciation component.

• The CEO Dilemma: When a company has excess profit, management must make a decision:

  • Pay a Dividend/Buyback: Management is essentially admitting there are no high-growth, Net Present Value (NPV) positive projects internally, so they are returning the money to shareholders.

  • Reinvest: Management believes they can turn the profit into more money by investing in new projects.

• The Truth: Obsessing over high dividend yield can lead you to invest in companies with low growth potential simply because they pay out. This can cause you to miss out on the superior compounding growth of companies that choose to reinvest their profits efficiently. Focusing too heavily on dividend yield distorts your investment decision-making.

Final Action

If your advisor is unwilling or unable to discuss these three areas—Portfolio Overlap, Bond Markups, and the true meaning of Dividend Yield—it's a sign that you might be getting expensive, undifferentiated advice.

At Barrett FP LLC, we offer expert financial planning on an hourly basis, focused entirely on helping you achieve your goals.

Learn more about how we can help you build an objective, data-driven investment plan.