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By Jason Stipp and Christine Benz | 09-25-2013 12:00 PM

Benz: 5 Tips for Your Third-Quarter Portfolio Checkup

Beyond noting their stock/bond split, investors should also check their small-cap exposure, overall rate sensitivity, and vulnerability to the wealth effect.

Jason Stipp: I'm Jason Stipp for Morningstar.

How did an eventful third quarter ripple through investors' portfolios? Here to offer five important tips for your quarter-end portfolio checkup is Morningstar's director of personal finance Christine Benz.

Thanks for joining me, Christine.

Christine Benz: Jason, it's great to be here.

Tip 1: Check Exposure to Major Asset Classes
Stipp:
The first thing investors should check when they're opening up their portfolios at the end of the third quarter is probably the most important thing they should keep their eye on, which is the stock/bond mix. Stock performance this year certainly could have changed the proportion of that mix.

Benz: That's right. The third quarter was very good for equities. The whole year has been very good for equities. So, if you've done nothing to your portfolio in terms of rebalancing, readjusting those asset allocations, chances are they've changed quite a bit, and for a lot of people, that will mean that their portfolios are more equity heavy than they want them to be. That could call for considering whether it is time to rebalance back to your targets.

Stipp: Not only performance, but also it's good to keep an eye on valuations. When you look at the way Morningstar analysts value the stock market, it could be a good time also from that perspective to trim a little bit on stocks.

Benz: That's exactly right. So when we look at our coverage universe, what we see is a price-to-fair-value of about 1.02, a little over fair value currently. That's not a horrible sign for equities. It doesn't mean that equities will fall precipitously from here, but it does indicate that it's probably a good time to consider lightening up on stocks.

Stipp: The bond market has, obviously, been bumpy over the summer. If I'm trimming from stocks, are you telling me that I should take that money and plow it into bonds? Is now a good time to do that?

Benz: It seems very counterintuitive. There's been so much handwringing about what will happen with interest rates, and I think it's really reasonable to think that interest rates will indeed trend up over time, maybe to more normal levels from where they've been. But I do think that investors should, in fact, be taking some risk off the table in their portfolios if they are tilting more heavily toward equities than perhaps they intended.

I think at a time like this it's really important to remember why you have bonds in your portfolio in the first place, and it's the ballast that you need for your more volatile equity holdings. You need to have some very safe and steady holdings. That can be cash, but it could also be short-term and high-quality bonds. So to the extent that people have bonds in their portfolios, I think that they probably want to be thinking about that general complexion, remembering why they have them, and keeping those bond holdings pretty safe.

Tip 2: Check Equity Sub-Asset Class Exposures
Stipp:
We've checked our high-level asset allocation. You say it's also worth looking at some of the sub-asset classes, because we've seen some interesting performance differences among the different types of equities.

Benz: We have, for a change, because we had seen periods in the past couple of years where a lot of equities performed in lockstep. This year we've seen a bit of a gradation. So the big headline is that we've seen small- and mid-cap stocks, small-cap stocks in particular, dramatically outperform large. So if you have a dedicated small-cap fund or an allocation to that asset class, chances are it may be growing a little beyond your parameters for it.

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