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Get a Handle on Your Portfolio

Jason Stipp
Christine Benz

Jason Stipp: I’m Jason Stipp for Morningstar. Our Portfolio Makeover Week kicks off May 20, and Christine Benz, our director of personal finance, has been gleaning some insights from readers’ submissions, submitting their portfolios for review. She is here to talk about some frequent concerns and how investors might address them on their own.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: Among the concerns that you’ve seen over and over from readers who have submitted their portfolios to you is retirement readiness, and of course, the big question with retirement readiness is "Do I have enough money for my goals to actually retire?"

Benz: Right. This is such a common concern, and it’s only natural that you would want a second or a third opinion on this. So, even if you have crunched the numbers or worked with a financial advisor, it’s only natural that you would want to reach out and see whether you are on track to actually have enough during retirement.

Stipp: And you say that one of the things that a lot of folks will do is take a look at the raw number, and it will seem just too low. But that’s really just part of the story how much you have. It also depends on a lot of other factors.

Benz: It really does, and it depends mainly on your anticipated spending during retirement. So, for example, there was someone who wrote into me, and this person had roughly $320,000 in assets, getting ready to retire. That might seem to set off alarm bells, but this particular person had a pension, had Social Security, and had modest spending, so really their income needs were covered with the pension and social security. This $320,000 was just sort of some money on the side that was gravy essentially, and that was money that they would hope to invest well for their kids and grandkids.

So, the raw number alone is not enough. You really need to dig in, look at your anticipated spending needs, and crunch some numbers on that. You can use the simple 4% rule. You can use a calculator to see whether you are on track once you’re factoring in all of your income sources during retirement. One tool I often refer people too is the T. Rowe Price Retirement Income Calculator. Or I think this is a great [opportunity] to see a fee-only advisor to do that check for you, even if you feel really comfortable with your starting point that your nest egg is enough to last you throughout a long retirement. A financial advisor can really help you get comfortable with that number and whether you will have enough.

Stipp: So, let’s say I get some bad news when I crunch the numbers with a calculator, or I see an advisor, and it looks like there could be a shortfall. What are my levers? What can I do at this point?

Benz: It really depends on where you are in your life stage. So, if you are someone who is younger, your two big levers at that point are to continue working and to continue saving. If you are someone who is getting close to what you hope will be your retirement date, your levers are relatively less. You can either push your anticipated retirement date out a little bit, or I know this is not palatable, but you can plan to reduce your spending somewhat or make some lifestyle changes that will push down on your spending. Those are your choices at that standpoint.

Obviously, it’s better to run through these exercises as early in your life as you possible can and keep running them to make sure that you are still on track. And the earlier that you do it, the more changes you can make. You can also adjust your asset allocation, though it will tend to matter less than will some of these other factors such as reducing spending or continuing to work.

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Stipp: If I’ve got other things, such as I would like to save for my child’s college education or other big expenses, getting a handle on this number can help me to prioritize?

Benz: Absolutely. So, certainly there are a lot of people who are in that multitasking phase, people who are in their 30s and 40s. They want to work on their retirement contributions, but they also very much have as a priority the college savings. So, looking at how you’re doing on that retirement readiness is the key first step in determining how much you can actually invest for a college. Your kids will have more options if they get to college age and you haven’t saved that much, certainly more options than you will when you get to retirement and you find out you haven’t saved enough.

Stipp: Another related issue, perhaps more portfolio-related with retirement readiness, is the asset allocation. So, folks will wonder, "Do I have my assets in the right kinds of investments?" It’s a common question that you get.

Benz: Definitely, a lot of the makeover requests converge around that question. People say, "I think, I am too conservative." We’ve talked to a lot of people who went through that terrible bear market from 2007 through 2009. They got very conservative, and they never quite got out of that conservative crouch. That’s a common theme that I am seeing in some of the portfolio makeover requests.

Other people have the opposite predicament. They are coming close to retirement and suspect that they have way too much in stocks, given where they are at that life stage, and yet they are not that attracted to bonds. So, they’re looking for some guidance on what is an appropriate asset-allocation mix for them, given that retirement is close at hand.

Stipp: So, what are some good useful tools that I can use to at least know if I’m in the ballpark?

Benz: Well, I think that Morningstar’s Lifetime Allocation Indexes, which I have referred to in a lot of articles, can be a good starting point. Of course, this is off-the-shelf guidance, and it’s not customized. It’s not based on your individual situation, but I think it’s a good way to check to see if your asset allocation is in the right ballpark, and there are separate versions, so there is a conservative, moderate, and aggressive version. That aggressive allocation index would tend to be most appropriate for people who maybe have a lot of their income needs for retirement covered through other sources.

So, someone with a pension, for example, might look to the more aggressive asset-allocation mix for their portfolio because they can afford some of the ups and downs that come along with a higher equity weighting. Someone who has a very low risk tolerance and knows that they tend to make bad decisions in times of market duress may want to stick with the more conservative portfolio mix.

Stipp: And folks who are near retirement will often ask you about their liquid reserves or how much they have in cash. For some folks, they worry if they don’t have enough, other folks worry about having too much because interest rates are so low right now.

Benz: I think I’ve seen more of the second concern recently, people saying, "I have all of this cash." A lot of it was the result of people liquidating during the bear market, and they haven’t redeployed that money. But you definitely want to check to see where you are in terms of the liquid reserves. If you are someone who is working, you certainly need that baseline of three to six months’ worth of living expenses. If you’re someone who is close to retirement, what I usually recommend when I talk about that bucket strategy for in-retirement portfolio planning is thinking about one to two years’ worth of cash for living expenses in true cash reserves. So, think about certificates of deposit and money market funds. It is dead money as you say. It’s in the red actually once you factor in inflation, but the idea is that this is money that you’re keeping stable to meet your near-term living expenses.

Stipp: Speaking of inflation, that’s an important part of making sure that your allocation is correct, especially as you’re nearing retirement, that inflation protection piece?

Benz: Absolutely. So one thing we notice when we look at those Ibbotson Morningstar Lifetime Allocation Indexes is that the percent of explicit inflation protection increases quite a bit as someone gets close to retirement. So, when you’re thinking about your retirement portfolio, you want to think about certainly having stocks. That’s a great way to out-leg inflation over time, but you also want to think about having Treasury Inflation-Protected Securities. I like Vanguard’s new short-duration TIPS fund. And you want to think about possibly having some sort of commodities exposure, maybe not necessarily direct commodities exposure, but at least making sure that you have some good natural resources exposure, exposure to food companies, for example, in the equity portion of your portfolio.

Stipp: I’m going to go out on a limb, Christine, and say that we probably got some questions about income and "How do I produce income? What are my best choices for income-producing investments?" What would you say to those concerns?

Benz: Well, a lot of times what I see when I look at portfolios is people have built their portfolios very much for income, and that’s not unreasonable. But I think what you end up with sometimes is that, if you are prioritizing income, you can end up with a portfolio that looks very imbalanced. So it might be heavily dependent on just a couple of sectors, and so the person has prioritized income and in the process given short shrift to diversification and to overall total-return considerations. So certainly income needs to be part of your investment mix. But my strong bias is to focus on total return, and that’s why I often talk about that bucket strategy. It does use income-producing securities, but it embeds them within a total-return context.

Stipp: Another common concern is, not only do I have the right kinds of investments--stocks, bonds, inflation protections--but have I put them in the right kinds of accounts for the activities I need to do once I’m retired.

Benz: Absolutely. So that’s something I look at, if people have multiple pools of assets, and they often do, we make sure that we have the most tax-efficient assets going in the taxable account. So if they’re individual stock holdings, for example, they go there. If they’re municipal bonds, obviously, they should be there. Index funds are a great fit for taxable accounts. If you have things that kick-off a lot of income on a year-to-year basis--and almost nothing kicks off a lot of income right now--you want to make sure that you’re holding them within your tax-deferred or tax-free withdrawal accounts, like Roth accounts.

Stipp: Another big category of investor concerns with their portfolios is "My portfolio is a beast; it is an uncontrolled mess. I’ve got investment pools here and here and here. What’s a good way to at a macro level get a handle on all these different investments I’ve accumulated over time?"

Benz: This cuts across all age bands too, by the way. It’s not just people nearing retirement. It is people of all ages who have these sprawling portfolios. They’ve been kind of investment collectors throughout their lives and then know that they want to skinny it down at some point. So usually the first step for me when I’m thinking about a portfolio makeover is to think about, "Well, how do we combine some of these like accounts?" So if we’ve got an old 401(k) plan over here, that’s a good candidate for maybe rolling over into this IRA. Or if you have multiple taxable accounts, that’s a good first step to sort of collapse some of the accounts and try to pack some of the holdings behind the higher-conviction names.

Stipp: What about if I have individual stocks hanging around in my portfolio?

Benz: I think it depends on the individual’s commitment to managing that individual stock portfolio. We’ve talked about this before. A lot of investors have little portfolios that they really don’t do a lot with. They have decided that they probably don’t want to spend the time they need to spend to pick individual stocks. In that case, if they’re smaller positions that aren’t adding a lot to the total portfolio’s bottom line, I usually do recommend that they go into mutual funds instead. But again, some investors are very committed to using individual equities, and that’s fine. It just does depend on the investor’s engagement level.

Stipp: What about my mutual funds? What’s a good way to streamline those?

Benz: I always look for some of those region-specific funds, sector-specific funds. Oftentimes they’re redundant with something else that’s in the portfolio, so I look for ways to collapse along those lines. Take the more narrowly focused funds, take those assets and pack them behind the more diversified holdings.

Stipp: I might also have some legacy positions, maybe stock from an old job, or a gift from a grandparent that’s been in there for a long time. How should I think about a stock that might be in there that has kind of a legacy like that?

Benz: This is a very common issue, where someone has a well-diversified portfolio, except for this giant position in X stock, and oftentimes it is some sort of legacy situation, a former employer or something like that.

I typically would recommend that people keep individual stock holdings to less than 5% of the portfolio, if possible, even if it’s not your current employer and you don’t have that economic problem of having your livelihood intertwined with your portfolio. I still think it makes sense to keep those individual positions down at less than 5%. Of course, you want to look at whether it’s opportune or inopportune time to sell that particular holding. Right now, with the market having lifted so many boats, I think it’s probably a good time to think about trimming back some of those positions. But of course, you also want to bear in mind any tax considerations if you’re holding that particular position outside of some sort of tax-sheltered retirement plan.

Stipp: Christine, we’re very much looking forward to Portfolio Makeover Week, which starts May 20. Thanks for giving us a preview of some of the big concerns that investors are facing right now.

Benz: Thank you, Jason.

Stipp: For Morningstar, I’m Jason Stipp. Thanks for watching.