Check up on your portfolio's health--and that of your whole plan--as the year winds down.
By Christine Benz | 12-04-17 | 05:00 AM | Email Article

In years like 2017, it has been easy to get a bit lax about your portfolio. If you're busy, the fallback has likely been to peer at your enlarged balance periodically, say "Yay for me!" and leave well enough alone.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

That sort of laissez-faire approach has been rewarded thus far this year, especially for investors with sizable equity stakes. Through the end of November, the S&P 500 has returned more than 20%, and Morningstar's Large Growth Index has gained nearly 10 percentage points more than that.

Foreign stocks have soared, too, while equity-market volatility has been notably absent. Even bonds, the subject of much hand-wringing earlier in the current economic recovery, have logged solid if unspectacular gains.

Yet even as portfolios have been placidly racking up strong returns, the extended string of equity-market gains means that risk levels are elevated, too. A portfolio that was 60% equity and 40% bond at the beginning of this year would be 64% stock/36% bond today. A 60% stock/40% bond portfolio at the outset of the current rally--dating to March 2009--would be 83% stock/17% bond right now, assuming an investor hadn't added or subtracted to stocks over that period. Even if stocks' valuations aren't elevated--and there are indications that they are--portfolios with more stocks in them are inherently more volatile than those with more bonds.

Those escalated equity levels--combined with the fact that you're almost nine years older and nine years closer to drawdown--suggest that it's time to revisit your portfolio's exposures, as well as the viability of your total plan. As you do so, follow these six steps.

Step 1: Conduct a 'wellness check.'
It's helpful to think of the portfolio review process as an inverted triangle--the biggest, most important jobs belong on top, while less impactful tasks can fall to the bottom. That way, if you run short on time and have to skip the later jobs, you'll at least have tackled the crucial ones. With that framework in mind, it makes sense to 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 up your various savings across all accounts so far in 2017: 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 college funding for children or a home down payment. If your 2017 savings rate will fall short of what you'd like it to be, take a closer look at your household budget for spots to economize. In addition to assessing savings rate, take a look at your portfolio balance: Fidelity Investments and JP Morgan have both developed helpful savings amount benchmarks to gauge if you're on track. (In the JP Morgan PDF, the benchmarks are on page 12.)

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% guideline is a good starting point. (Remember: The 4% guideline isn't about taking 4% of your portfolio year in and year out.)

All-in-one retirement calculators can also be useful when assessing the viability of all aspects of your plan. Tools like T. Rowe Price's Retirement Income Calculator and Vanguard's Retirement Nest Egg Calculator bring all of the key variables together and help you identify areas for improvement.

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 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 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. If you don't have targets, Morningstar's Lifetime Allocation Indexes are useful benchmarking tools. High-quality target-date series such as those from Vanguard and BlackRock's LifePath Index Series can serve a similar role for benchmarking asset allocation. My model portfolios can also help with the benchmarking process. 

As noted, many investors' portfolios are listing toward equities right now. 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; focus on tax-sheltered accounts to move the needle on your total portfolio's asset allocation.

Step 3: Check the adequacy of liquid reserves.
In addition to checking up on your portfolio's long-term asset allocations, 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: Assess sub-allocations and troubleshoot other portfolio-level risk factors. 
For a few years there, U.S. stocks of every persuasion seemed to move in lockstep: Value stocks' performance was in line with growth names, while small caps' returns were in line with large. Not so in 2017 thus far. Through November, domestic growth stocks across the market-cap spectrum have outperformed value names by a wide margin. Check your portfolio's style-box exposure in X-Ray to see if it's tilting disproportionately to growth names. As a benchmark, a total U.S. market index fund holds roughly 24% in each of the large-cap squares, 6% apiece in the mid-cap boxes, and 3% in each of the mid-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 S&P 500 for benchmarking. Technology and healthcare stocks have paced the current rally and are likely to be overweight positions in many portfolios.

On the bond side, review your positioning to ensure that your bond portfolio will deliver ballast when you need it. Thus far in 2017, lower-quality bond types like emerging markets and high yield have thrived while returns from higher-quality options have been underwhelming. If you're rebalancing 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 5: Review holdings. 
In addition to checking up on allocations and sub-allocations, take a closer look at individual holdings. Scanning Morningstar's qualitative ratings--star ratings for stocks and Medalist ratings for mutual funds and ETFs--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 6: Attend to tax matters.
Year-end is also your deadline for several tax-related to-dos, some of which touch your portfolio. If you're still in accumulation mode, review how much you're contributing to each of the tax-sheltered account types that are available to you: IRAs, company retirement plans, and health savings accounts. You have until your tax-filing deadline to make contributions to an IRA and/or HSA for the 2017 tax year, but Dec. 31 is your deadline for making 2017 contributions to company retirement plans such as 401(k)s and 403(b)s. Contribution limits for 401(k)s are currently $18,000 for the under-50 set and $24,000 for those over 50, though they'll be increasing to $18,500 and $24,500, respectively, next year.

In addition, retirees must take required minimum distributions from tax-deferred accounts. I'm a big believer in taking a surgical approach to RMDs, using those withdrawals to correct portfolio problem spots. This article takes a closer look at tying in RMDs with rebalancing. 

As 2017's rocketlike market winds down, candidates for tax-loss selling will be few and far between. Energy investors may be able to identify some losing positions, though; just be sure to mind the wash-sale rule, which states that you can't buy an identical or substantially identical position within 30 days of selling it. Investors in the 10% and 15% income tax brackets may be able to improve their future tax positions with tax- gain harvesting

Charitably inclined investors can also consider a host of tie their portfolios in with charitable giving, discussed here, including qualified charitable distributions from IRAs for RMD-subject retirement accounts. 

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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