Morningstar's complete midyear portfolio checkup
Reviewing your year's performance so far and positioning yourself for the future.
If we were to close the books on the year right now, most investors would be pretty satisfied with their portfolios’ results. (Unless, that is, they hunkered down in cash during last year’s turmoil and never got out of their defensive crouch.)
Bonds have been no great shakes, roiled by interest-rate and inflation worries, but slightly higher yields aren’t exactly unwelcome. Meanwhile, stocks have enjoyed broad-based strength. While the market had been dominated by a narrow handful of technology stocks for much of the past few years, value stocks have come on strong in 2021, buoyed by the prospect of an economic resurgence.
The fact that 2021 has featured a surprise or two--and may offer more surprises ahead--makes it an opportune time to check up on your portfolio. As you go through the process of checking up on your portfolio and your plan, here are the key items to keep on your dashboard.
Step 1: Conduct a wellness check.
Start with an assessment of the state of your plan. Are you on track to reach your financial goals?
If you're still accumulating assets for retirement, check up on whether your current portfolio balance, combined with your savings rate, puts you on track to reach whatever goal you're working toward. Tally your various contributions across all accounts so far in 2021: A decent baseline savings rate is 15%, but higher-income folks will want to aim for 20% or even higher. Not only will high earners need to supply more of their retirement cash flows with their own salaries (Social Security will replace less of their working incomes), but they should also have more room in their budgets to target a higher savings rate. You'll also need to aim higher if you're saving for goals other than retirement, such as education funding for children or a home down payment. In addition to assessing your savings rate, look at your retirement portfolio balance.
If you're retired, the key gauge of the health of your total plan is your withdrawal rate--your planned portfolio withdrawals for 2021, divided by your total portfolio balance at the beginning of the year. The "right" withdrawal rate will be apparent only in hindsight. The 4% guideline is often held out as a good starting point, having been stress-tested over a variety of time periods. However, some retirement experts argue that today's low bond yields argue for an even lower starting withdrawal rate. The past year has provided fewer spending opportunities than in normal times, but as opportunities to travel and eat out multiply, spending could be harder to control.
Step 2: Assess your asset allocation.
Once you've evaluated the health of your overall plan, turn your attention to your actual portfolio. Morningstar's X-Ray view--accessible to investors who have their portfolios stored on Premium.Morningstar.com -- provides a look at your total portfolio's mix of stocks, bonds, and cash. (You can also see a lot of other data through X-Ray, which I'll get to in a second.) You can then compare your actual allocations to your targets.
As noted earlier, thanks to the long-running rally, many hands-off investors are apt to find that their portfolios are quite heavy on stocks relative to the above benchmarks. A portfolio that tilts mostly or even entirely toward stocks is fine for younger investors with many years until retirement. At this life stage, you absolutely need the growth potential that comes along with stocks, so it usually makes sense to maintain as high an equity allocation as you can tolerate And it’s not like the alternatives are all that appealing right now, with cash and bonds yields still extremely low.
But a too-heavy equity portfolio is a far more significant risk factor for investors who are nearing or in drawdown mode: Insufficient cash and high-quality bond assets to serve as ballast could force withdrawals of stocks when they're in a trough, thereby permanently impairing a portfolio's sustainability. If your portfolio is notably equity-heavy relative to any reasonable measure and you're within 10 years of retirement, derisking by shifting more money to bonds and cash is more urgent. You could make the adjustment all in one go or gradually via a dollar-cost averaging plan. Just be sure to mind the tax consequences of lightening up on stocks as you're shifting money into safer assets.
Step 3: Assess adequacy of liquid reserves.
In addition to checking up on your portfolio's long-term asset allocations, midyear is a good time to check your liquid reserves. A dedicated emergency fund is of course the best option: I recommend that working people hold three to six months' worth of living expenses in liquid reserves, and higher-income workers and contractors/gig economy workers should target an even higher cushion.
For retired people, I recommend holding six months' to two years' worth of portfolio withdrawals in cash investments; those liquid reserves can provide a spending cushion even if stocks head south or bonds take a powder. Retirees whose portfolios are equity-heavy can use rebalancing to top up their liquid reserves.
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Cash yields are still pretty low right now, but income isn’t the point here. Instead, the idea is to make sure that you have safe assets that you could turn to for spending in a pinch.
Step 4: Assess your equity positioning.
Your broad asset-class exposure will be the key determinant of how your portfolio behaves. But your positioning within each asset class also deserves a closer look, especially because we’ve seen a bit of a Morningstar Style Box rotation thus far in 2021. Growth stocks have been more than solid, but they’ve been overshadowed by the recovery in long-suffering value names. Check your portfolio's Morningstar Style Box exposure in X-Ray to see how your equity holdings are arrayed across the size/style grid.
While you're at it, check up on your sector positioning; X-Ray showcases your own portfolio's sector exposures alongside those of the S&P 500 for benchmarking. Additionally, check your portfolio's allocation to foreign stocks.
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Step 5: Evaluate your fixed-income exposures.
On the bond side, review your positioning to ensure that your bond portfolio will deliver ballast when you need it. Thus far in 2021, lower-quality bond types have outperformed higher-quality ones. Lower-quality bonds tend to benefit during economic recoveries, whereas higher-quality bonds tend to be more vulnerable when the economy is going strong and yields are trending up. If you're adjusting your fixed-income portfolio, redeploying money from higher-risk bond segments into lower-risk alternatives will improve your total portfolio's diversification and risk level, even as it's likely to lower the yield. To the extent that you make room for lower-quality bonds, think of them as equity alternatives, not bond substitutes.
Step 6: Check up on your individual holdings.
In addition to checking up on allocations and suballocations, take a closer look at individual holdings. Scanning Morningstar's qualitative ratings—Morningstar Ratings for stocks and Morningstar Medalist ratings for funds and exchange-traded funds--is a quick way to view a holding's forward-looking prospects in a single data point.
If you're conducting your own due diligence, be on alert for red flags at the holdings level. For funds, red flags include manager and strategy changes, persistent underperformance relative to cheap index funds, and dramatically heavy stock or sector bets. For stocks, red flags include high valuations and negative economic moat trends.
Also take note of highly appreciated positions that are taking up a larger share of your portfolio than might be ideal. (More than 5% of your total equity assets is a good benchmark for “too much.”)
Step 7: Make changes judiciously.
Whether you act on any of the conclusions you drew from your fact-finding in Steps 1-6 depends on a couple of factors--the type and severity of the issue, as well as your life stage and situation and the parameters you've laid out in your investment policy statement.
If you're many years from retirement, tend to be unruffled by market volatility, and your portfolio has 90% in stocks even as many asset-allocation benchmarks suggest 80% or 85% for people at your age, repositioning your long-term portfolio probably isn't urgent. But if you do decide to make changes, be sure to take tax and transaction costs into account.
Making changes can be more pressing if you're getting close to or in retirement, especially if your portfolio is too aggressively positioned and you don't have enough in safe assets to tide you through sustained weakness in the stock market. In that case, it's wise to think about redeploying some of your enlarged equity portfolio into cash and bonds.