Christine Benz on How to Conduct a DIY Portfolio Makeover
Is your investment portfolio working as hard as it could be? A periodic review is essential to ensure your investments align with your financial goals and the current market landscape. During a recent webinar for Morningstar Investor subscribers, Morningstar's Christine Benz shared her expert approach to conducting a portfolio makeover, offering practical strategies to refine, streamline, and improve your financial position.
In the following key takeaways from her session, you'll find Christine's recommended steps to give your portfolio the refresh it deserves.
1. Review Your Financial Goals
Before diving into your investments, take a step back and look at the bigger picture. The first step in any portfolio makeover is a thorough review of your objectives so you can course-correct as needed.
Check Your Emergency Fund
Your emergency fund is your first line of defense against unexpected financial shocks. If you’re still working, Christine Benz suggests you aim for three to six months' worth of living expenses in liquid reserves. For retirees, a larger cushion of one to two years' worth of expenses is a good target.
Evaluate Your Retirement Savings
Retirement is the primary savings goal for most people. To see if you are on track, consider two key metrics: your savings rate and your total accumulated nest egg.
- Savings Rate: A good baseline for your annual retirement savings is 15% of your income. If you are a higher earner, you should aim for 20% or even 25%. Remember that contribution limits for IRAs and company retirement plans like 401(k)s often adjust for inflation, so check if you can increase your contributions.
- Savings Benchmarks: Fidelity offers useful benchmarks to gauge your progress. For example, by age 30, you should have 1x your annual salary saved. This target increases to three times your salary by age 40 and six times by age 50.
If you are nearing retirement, the "4% rule" is a helpful guideline for determining if your savings are sufficient. This rule suggests you can withdraw 4% of your portfolio in your first year of retirement, and then adjust that amount for inflation in subsequent years. Pair this with your other income sources, like Social Security or a pension, to see if it covers your expected living expenses.
Assess Other Financial Goals
Don't forget other objectives, such as saving for your children's education or other short- and intermediate-term goals. For each goal, ask yourself: how much will I need, when will I need it, and are my current investments on the right path to get me there?
2. Evaluate Your Portfolio's Positioning
After your savings and spending rates, your asset allocation is the single biggest factor determining your portfolio's performance.
Your Asset Allocation Mix
Start by looking at the broad breakdown between stocks, bonds, and cash; this is your foundation. Not sure if your mix is appropriate? Christine suggests looking at target-date funds for your age group or model portfolios as a benchmark. Your asset allocation should primarily be determined by your time horizon.
Use X-Ray and Stock Intersection to Examine Your Portfolio's Exposure
Beyond the basics, examine your portfolio's exposure to different styles, sectors, and geographic regions. You can use the X-Ray and Stock Intersection features within Morningstar Investor’s portfolio tool to accomplish this.
- Geographic Exposure: Many investors are heavily weighted towards their home country. A good benchmark for your equity portfolio's geographic split is the global market capitalization, which is currently around 63% US and 37% non-US stocks. International stocks can offer diversification, different sector exposure (like financials and industrials), and potentially better valuations.
- Sector & Style: Check for over-concentration in specific market segments. For example, the US market is currently tilted towards large-cap growth and technology stocks. Ensure you have exposure to other areas like value stocks and smaller-cap companies.
- Individual Stock Overload: Be wary of having too much of your portfolio in a single stock, particularly employer stock. An allocation of more than 5% to any individual holding adds significant concentration risk that you may not want.
3. Understand Asset Location for Tax Efficiency
Asset allocation is what you own; asset location is where you own it. Holding investments in the right type of account can significantly improve your tax efficiency.
Within tax-sheltered accounts like an IRA or 401(k), you can hold almost any investment without a worry. The picture changes for taxable brokerage accounts. For these accounts, consider holding tax-efficient investments:
- Equities: Index-tracking funds, ETFs, and individual stocks are generally a good fit.
- Bonds: If you are in a higher tax bracket, tax-free municipal bonds and municipal money market funds can be more advantageous than their taxable counterparts.
What if you have the right investment in the wrong account? Christine’s advice is to proceed with caution. With markets having performed well, selling an investment in a taxable account could trigger a large capital gains tax bill. A simple first step is to stop reinvesting dividends and capital gains distributions for any tax-inefficient holdings in your taxable account to prevent buying more shares.
4. Streamline Your Portfolio for Simplicity
A complex portfolio with dozens of holdings and multiple accounts is difficult to manage. Streamlining makes your life easier and is a great favor to any loved ones who may one day have to manage your finances.
While you can't merge every account—retirement accounts must remain separate, for example—you can still clean things up. You can often consolidate old 401(k)s and traditional IRAs. For holdings, consider using broad-market index funds or all-in-one funds. These minimalist options provide instant diversification within a single investment, which is perfect for simplifying smaller accounts like a Roth IRA.
5. Assess Your Holdings Quality
Once you've reviewed your overall structure, it's time to examine the quality of your individual investments to make sure that they’re best-of-breed. Use resources that come with Morningstar Investor subscription to read analyst reports and check ratings for stocks, funds, and ETFs, including Morningstar Ratings for stocks and Morningstar Medalist Ratings. This step ensures that the building blocks of your portfolio are solid and worth holding for the long term.
6. Make Tax-Efficient Changes
If your portfolio review has identified problem spots, the final step is to make changes as tax-efficiently as possible.
- Taxable Accounts: As mentioned, pause before selling appreciated assets in taxable accounts. Get financial advice if you are unsure. However, if you have any holdings with losses, you can sell them to realize a tax loss, which can offset other gains.
- Adding to Your Portfolio: If you find you are underweight in stocks, consider a dollar-cost averaging strategy. This involves investing a fixed amount of money at regular intervals, which can reduce risk compared to investing a large lump sum at once. Focus on areas that haven't performed as well recently, such as smaller-cap, value, and international stocks.
Your path forward
Conducting a portfolio makeover helps ensure your financial plan remains robust and aligned with your life goals. Take the time to review your goals, analyze your asset allocation, and assess your holdings. By following these steps, you can build a more streamlined, tax-efficient, and effective portfolio.
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