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Year-end portfolio review: 4 easy steps

Christine Benz  |  08 Jan 2020Text size  Decrease  Increase  |  
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The holiday season is winding down. Some of us are squeezing in extra time with friends and family, others are returning holiday gifts, and still others are using this typically quiet time of year to clean off their desks at work.

Portfolio maintenance may not be top of mind for many this time of year, but it should be. Given what the markets may have done to your thoughtfully conceived asset allocation this year, it's worth making the time to do at least a quick portfolio review.

Here are the key steps to take.

Step 1: Conduct a 'wellness check'

Begin your portfolio checkup by answering the question: "How am I doing on my progress to my goals?"

For accumulators, that means checking 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 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 own salaries, 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. If your 2018 savings rate will fall short of what you'd like it to be, take a closer look at your household budget for spots to economise.

If you're retired, the key gauge of the health of your total plan is your withdrawal rate--all of your portfolio withdrawals for this year, 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.)

Step 2: Assess your asset allocation

Given stocks' very robust performance in 2019, many investors' portfolios are heavy on equities. That's not a huge deal for younger investors with many years until retirement, but 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.

Step 3: Check the adequacy of liquid reserves

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Your year-end portfolio review 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 essential; 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. Retirees whose portfolios are equity-heavy can use rebalancing to top up their liquid reserves.

Step 4: Review holdings

Take a closer look at individual holdings. Scanning Morningstar's qualitative ratings--star 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 moat trends.

A version of this article first appeared on Morningstar.com. It has been edited for an Australian audience.

is Morningstar's director of personal finance.

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