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By Christine Benz | 07-09-2014 03:00 PM

A Portfolio Checkup in 6 Steps

In this special midyear presentation, Morningstar's Christine Benz demonstrates how to gauge the viability of your current plan, evaluate positioning, troubleshoot risk factors, and much more.

Christine Benz: Hi, I'm Christine Benz for I'm here to share with you a session about how to conduct a midyear portfolio checkup. I will run through six steps that you can take when checking up on your own portfolio. But before we get into that, I'd like to talk about what I think are best practices for portfolio checkups in general.

The first point I would make is that it's a mistake to check up on your portfolio too frequently. I think for most investors a quarterly checkup is plenty. If you wanted to be even more hands-off you might think about just checking up on your portfolio semiannually or even maybe just once a year. It's also important if you are conducting a portfolio checkup to be targeted about it. Employ a checklist so you can get in and get out. You don’t want the process to take hours or days. It should take just an hour or two at the most. The idea is to be surgical and get it done.

Another best practice for portfolio checkups is to focus on the fundamentals of your portfolio. We have come through a period where both stocks and bonds have performed pretty well. So it's easy to get distracted by the performance of our holdings and by the strength of our portfolios in general. But I think it's very important for investors to anchor their portfolio review process in a review of the fundamentals of their holdings as well as their asset allocations as well as whether their plans are on track.

It's also important if you are conducting a portfolio review to progress from the most important factors to the least important. That way if you run out of time, you will know that you have focused on the factors that are the most predictive of good performance for that portfolio.

And finally if you run through your portfolio-review process and decide that it's time to make changes, it's important to take tax and transaction costs into account before making any changes. For most investors I would say, it makes sense to do any trading within their tax-sheltered accounts where they won't incur any tax costs if they need to make changes. So, start with your IRAs and 401(k)s and see if you can move the needle there in terms of adjusting your portfolio's mix before working with any taxable holdings that you might have.

Let's get right into the six steps for conducting that portfolio review. The first step, the most important part of this process, is to gauge the viability of your plan. See if you are on track toward reaching your goals, and I will share some guidelines for both accumulators, people who are working toward retirement as well as people who are already retired.

The next step is really the meat of the portfolio review process. This is where you review your portfolio's asset allocation and its positioning versus various benchmarks. And I will share some of those benchmarks in the course of this review process.

The next step, and this is something that is important for both accumulators and for retirees, is to check liquid reserves in the portfolio. Make sure that you have adequate cash on hand to meet near-term living expenses or emergency expenses if you're still working.

You will also want to review individual holdings, and I'll share some ways to do that, using tools that are part of's Premium Membership.

For the timely part of the portfolio review, I'll talk about some current risk factors that should be top-of-mind for investors right now. You want to troubleshoot them as part of your review process.

And finally, and this is a very important part of any portfolio review, it's valuable to conduct a cost audit of your portfolio to make sure that you're not overpaying, if you have actively managed or indexed funds in your portfolio, that you are not paying too much for your total portfolio mix.

Step 1: Gauge Viability of Current Plan 
Let's get right into Step 1, this is making sure that your plan is on track. If you are an accumulator, you want to think about a few different benchmarks to gauge whether your savings program is on track. I recently sat down with Christine Fahlund, she was T. Rowe Price's lead retirement planner for many years. She said that T. Rowe is recommending that pre-retirees save about 15% of their income.

I think that's a reasonable starting point, but it's important to bear in mind that if you are a higher-income earner, you probably want to set aside an even higher percentage of your salary. The reason is that as you become retired, Social Security will provide a lower percentage of your income, so you will need to supplant that with your portfolio.

On Fidelity's website, Fidelity also provides some benchmarks for accumulators to help gauge whether they are on track. Fidelity says that by age 35 you want to make sure that you have set aside at least 1 times your current salary. Once you are at 45, you want to have 3 times your current salary per Fidelity's guidelines, and for people who are at 55, they want to make sure they will have 5 times current salary. Those are good benchmarks but again higher-income people will want to set their targets even higher.

You also want to make sure, because it is midyear, that if you are in a position to max out your contributions to your tax-sheltered account, that you are on pace to do so. So in 2014 people who are under age 50 can save $17,500 in a 401(k). People who are over age 50 can save $23,000. For IRAs, the contribution limits are lower, $5,500 for people under 50 and $6,500 for people who are over age 50. See how you are progressing toward maxing out those contributions.

You can either dollar-cost average, or, if you're doing an IRA, put the money to work in the market as soon as you possibly can. The idea being that over time people who make contributions early in the year tend to end up with larger account balances than those who wait until the very last moment.

Another way to gauge whether you're on track, if you're in accumulation mode, is to use one of the many calculators online. The beauty of these calculators is that they can take into account all of your different account types, and they can also use Monte Carlo analysis to help model out various return scenarios for your portfolio.

A few different tools that I like are T. Rowe Price's Retirement Income Calculator, Fidelity has its Retirement Quick Check tool for a quick back-of-the-envelope-type calculation, and retired investors have told me that they really like Fidelity's Retirement Income Planner when thinking about crafting their retirement plans.

These are all some of the good tools out there on the web. I would say sample a range of different tools to get a range of opinions about whether you're on track with your retirement plan. No matter what tool you use, make sure that it's as holistic as it can possibly be and is taking into account the major factors that would affect your retirement readiness. So you want to make sure that any tool you are using is factoring in inflation and that it's also using reasonable return expectations. Ideally it's using some sort of Monte Carlo Analysis to factor in the randomness of returns over time.

A good tool would also factor in the role of taxes and the tax treatment of your various account types as well as the role of other assets in your retirement plan. So the role of Social Security for example, or if you or your spouse has a pension, the best tools are holistic and take all of those different factors into account.

If you are someone who is getting ready to retire or already retired, you want to think about the sustainability of whatever withdrawal rate you're using in that portfolio. The old rule of thumb, the old guideline for sustainable withdrawal rates is that you can take 4% of your balance in year one of retirement and then gradually inflation-adjust that figure as the years go by.

So an example that I have got here, with an $800,000 portfolio that would mean that you could take $32,000 in year one of retirement and then you're just nudging that number up a little bit to account for inflation. So assuming a 3% inflation rate, you would be able to take about $33,000 in year two of retirement.

It's important to note that this idea of sustainable withdrawal rates has received a lot of scrutiny in recent years. My colleague David Blanchett, who is head of retirement research here at Morningstar, authored a paper where he looked at what he called the 3% rule. And what he suggested was that for people, particularly those with heavy fixed-income and cash balances, they want to be even more conservative than 4% when thinking about their withdrawal rates for their portfolio; that they may want to think in the neighborhood of 3%. So this is all important to bear in mind as you gauge your retirement plan. Keep an eye on your spending rate. Make sure that it passes the sniff test of reasonableness.

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