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A 7-step guide to reviewing your portfolio

Christine Benz  |  03 Jul 2019Text size  Decrease  Increase  |  
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The start of a new financial year is a good time to take a fresh look at your portfolio and your plan. You may find that your enlarged portfolio is also courting a good bit of risk, which can be particularly problematic if retirement or spending on other goals is close at hand.

As you conduct a portfolio review, here are the key steps to take.

Step 1: See how you’re doing

Before you get mired in the details of your portfolio, start with your plan. Are you on track to reach your financial goals?

If you’re still accumulating assets for retirement, check 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 2019: A decent baseline savings rate is 15 per cent, but higher-income folks will want to aim for 20 per cent or even higher.

Not only will high earners need to supply more of their retirement cash flows with their portfolio withdrawals or other sources, 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 university fees for children, or a home loan deposit. In addition to assessing your savings rate, take a look at your portfolio balance.

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If you're retired, the key gauge of the health of your total plan is your withdrawal rate - your planned portfolio withdrawals for 2019, divided by your total portfolio balance at the beginning of the year.

The "right" withdrawal rate will be apparent only in hindsight, but the 4 per cent guideline is a good starting point. (Remember: The 4 per cent guideline isn't about taking 4 per cent of your portfolio year in and year out.) If you’ve had a big-spending first half, there’s still time to rein it in so that your 2019 withdrawal rate comes in at a comfortable level.

All-in-one retirement calculators can also be useful when assessing the viability of all aspects of your plan.

Step 2: Assess your asset allocation

Once you've evaluated the health of your overall plan, turn your attention to your actual portfolio. 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 Morningstar.com or via Morningstar's Instant X-Ray tool - provides a look at your total portfolio's mix of stocks, bonds, and cash.

You can then compare your actual allocations to your targets. If you don't have targets, Morningstar's Lifetime Allocation Indexes are useful benchmarking tools.

If you've been hands-off, you may well find that your portfolio is quite heavy on stocks relative to the above benchmarks.

A portfolio that is mostly, or even entirely, invested in stocks isn’t a huge deal for younger investors with many years until retirement.

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, de-risking 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; focus on tax-sheltered accounts to move the needle on your total portfolio's asset allocation.

Step 3: Assess adequacy of liquid reserves

In addition to assessing your portfolio's long-term asset allocations, mid-year is a good time to check your liquid reserves. If you're still working, holding at least three to six months' worth of living expenses in cash is a good target. Higher-income earners or those with lumpy cash flows (looking at you, "gig economy" workers) should target a year or more of living expenses in cash.

For retired people, I recommend 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. (Financial planner Harold Evensky, who I consider the originator of the bucket approach, says he targets one year's worth.) Retirees whose portfolios are equity-heavy can use rebalancing to top up their liquid reserves.

In addition to checking up on the amount of liquid reserves that you hold, also take another look at where you're holding that money. Cash yields have declined a bit in 2019’s first half, but they’re still better than they were a few years ago.

Step 4: Assess your equity portfolio positioning

Your broad asset-class exposure will be the key determinant of how your portfolio behaves. But your positioning within each asset class also merits a closer look.

Check your portfolio's Morningstar Style Box exposure in X-Ray to see if it's tilting disproportionately to growth names.

As a benchmark, a total Australian market index fund holds roughly 24 per cent in each of the large-cap squares, 6 per cent apiece in the mid-cap boxes, and 1 per cent in each of the small-cap boxes.

Not every portfolio has to be right on the top of the index, but the style-box view lets you see if you're making any big inadvertent bets.

While you're at it, check up on your sector positioning; X-Ray showcases your own portfolio's sector exposures alongside those of the ASX 100 for benchmarking.

Additionally, check your portfolio’s allocation to foreign stocks.

Foreign stocks won't necessarily perform better than Australian stocks in an equity-market sell-off, and may even underperform the local market. But younger investors, especially, should be on guard against "home-country bias," which can undermine their portfolios' long-term returns.

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.

When your equities are down, history suggests that the most boring, highest-quality bonds will tend to hold up best.

If you're adjusting your fixed-income portfolio, redeploying money from higher-risk bond segments into lower-risk alternatives (think high-quality, short- and intermediate-term bond funds) will improve your total portfolio's diversification and risk level.

Step 6: Check up on your holdings

In addition to checking up on allocations and sub-allocations, take a closer look at individual holdings. Scanning Morningstar's qualitative ratings - Morningstar Analyst Ratings for stocks and Morningstar Medalist ratings for mutual 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 moat trends.

Step 7: Make changes judiciously

Whether you act on any of the conclusions you drew from your fact-finding 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 per cent in stocks even as many asset-allocation benchmarks suggest 80 per cent or 85 per cent 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. Focus any selling in your tax-sheltered accounts, where you won’t incur tax costs to do so, and you can usually skirt transaction costs, too.

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.

If you’re subject to required minimum distributions, consider harvesting appreciated equity holdings to help source your distributions; you don’t have to wait until year-end to do so.

is Morningstar's director of personal finance.

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