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Benz: Hold Your Nose and Rebalance

Jason Stipp
Christine Benz

Jason Stipp: I'm Jason Stipp for Morningstar.

As the first quarter is winding down, we're checking in with Christine Benz, our director of personal finance, for some tips on making sure your portfolio is on track--and doing some spring cleaning along the way.

Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: As always with your portfolio checkups, you say start at the general level, the asset allocation level. If I haven't checked my asset allocation for a while, what might I see when I crack open that portfolio?

Benz: You are likely to see higher exposure to equities than perhaps would be your target allocation. When we have strong equity markets, a little bit of inertia tends to set in, and you tend not to want to mess with a good thing if you see your returns going up and up. But chances are, most people's portfolios are pretty equity-heavy relative to their targets if they haven't done anything for the past few years.

Over the past year, even if you had a mediocre domestic-equity fund, it probably returned about 20%. Bonds, you were lucky to earn 2% or 3%. So chances are, things are a little bit out of whack. It calls for stripping back some of the equities and adding to fixed income.

Stipp: So sell some equities if they have gone over my target range and … buy bonds?

Benz: I know. Rebalancing is so counterintuitive, and really everyone hates fixed income right now. But you need to step back and think about why you're owning fixed income in your portfolio. It's not your return engine. Current yields have historically been a pretty good predictor of bond fund returns. At 2%-3% right now, you're not likely to earn great returns going forward.

But what you will have is the potential for much smaller losses or maybe even gains when the equity market goes down. You'll have that ballast. From that standpoint, I think bonds still makes sense, particularly for people who are getting close to retirement or certainly in retirement.

Stipp: Bonds are there to help with diversification. They are to provide ballast. Not necessarily there to be the biggest returning thing in your portfolio?

Benz: That's right. I think you also want to pick your spots within fixed income. Probably most people don't need long-term bonds in their portfolios. Stick with a good-quality, core intermediate-term fund, maybe a flexible fund. PIMCO Total Return has been in the headlines a lot lately, but I still like it. I know [Morningstar fund analyst] Eric Jacobson still likes it. It is a core holding. Harbor Bond, is the no-load analog. Or perhaps look to something like Dodge & Cox Income, where they've got a good value-leaning strategy. Just make sure that your fund is pretty opportunistic and free-ranging. I think that's what you want in a fixed-income market like the current one.

Stipp: That could take a little bit of the edge off if we do see rates tick up.

The next thing is, look at some of the sub-allocations--where your different types of equities are.

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Benz: With stocks what we've seen--not so much recently, but certainly when you look out over the past five years--is very strong performance from small-cap stocks. Small- and mid-cap growth stocks, in particular, have notched very strong performance relative to large caps.

Chances are, if you have some of that small-cap exposure, it's probably consuming an outsize stake of your equity portfolio. So, you might think of trimming there and perhaps redeploying those assets into large-cap stocks.

Stipp: What about on the fixed-income side? When I look at the different kinds of bonds I might have, what differences might I see?

Benz: One thing we've seen--and this has really paralleled the equity market rally--is that we've seen some of the more credit-sensitive bonds perform very, very well. Categories like high-yield and bank loans have performed terrifically. Chances are, if people haven't done anything to their bond portfolios, their portfolios are looking somewhat credit-sensitive at this point, given that those positions have probably grown in size.

So here, again, is another time when you may need to hold your nose and redeploy some assets. High-quality fixed-income holdings are probably the ones that need some love in your portfolio, because they are probably underrepresented at this point in time.

Stipp: Here is a tough question that a lot of investors grapple with. The market is up. They look at their portfolio, and their portfolio is up. But how can I really dig beyond that and understand, is it up as much as it could have been or should have been?

Benz: Benchmarking. I think this is such an important thing for investors to do, and I always think that an investor should take a step back if they are in that accumulation phase, look at their returns, ideally track your performance on Morningstar.com, where you've got your holdings in there. Look at your returns and simply compare them to that of a good target-date vehicle. Look at the target-date funds from T. Rowe Price or Vanguard that are geared toward people in your same age band. See how you are doing relative to those set-it-and-forget-it, really easy portfolio holdings. I would start with that as a simple benchmark.

Then I'm also a big fan of the idea of creating a custom benchmark--something very simple, composed of broad plain-vanilla index funds with very low expense ratios. Compare how your own portfolio and its asset allocation does relative to an index portfolio that mirrors your asset allocation. That way you can see if you are adding or subtracting value with your extra efforts. If not, maybe you are better off in the very low-cost vanilla portfolio.

Stipp: Lastly, what are some different ways you can simplify your life and your portfolio as you are doing a portfolio checkup?

Benz: Definitely, and this also ties in with tax time. I think we all have been looking at our documents; we've got them all on the desk. So it's time to look at where you are holding various investments, and think about whether you have opportunities to consolidate. If you're finding that you have to pull from here, there, and everywhere to get your statements together, because you have accounts all over the place, think about whether you might consolidate with maybe one or two very good providers.

This will give you a couple of opportunities: One is less oversight on an ongoing basis of your portfolio, so that's valuable. You may also be able to qualify for lower-expense share classes than you would by having smaller pools of assets all over the place.

The other thing a lot of firms are offering these days is at least some advice for people who have significant assets at the firm. So you might qualify for some tier of advice. Even if you're a dedicated, do-it-yourselfer, it's not a bad idea to get a second set of eyes on your plan, just to get a second-check on what you're doing.

Stipp: What about some funds that might overlap with other funds? How can I get a handle on that, because it seems like that would be a great area to streamline for my own time management, but also for my portfolio?

Benz: That's right. I feel like I'm always beating this horse about the issue of very narrowly focused holdings that investors tend to gravitate to. Right now, for example, I'm hearing about Fidelity Biotechnology everywhere I go. Whatever sector has been hot, people tend to want to buy. What ends up happening is, over time people end up with these little specialized holdings that maybe they really don't need in their portfolios.

If they have broadly diversified core holdings, they probably don't need individual sector funds. I don't think that most investors need region-specific funds, unless for some reason they want to own a fund by a specialist like Matthews in Asia--that's sort of a rarity. But for the most part, people don't need a lot of these specialized exposures. They'll do just fine owning broadly diversified funds, which also tend to have lower expense ratios than some of these more specialized investment types.

Stipp: For most investors, these specialized funds are a small part of their portfolio anyway, and as you said, probably duplicating some of the holdings in their core accounts.

You say also that consolidating your cash accounts can actually have a little bit of a lift on the yield side.

Benz: Potentially. Right now, nothing really matters with cash. No matter where you park your money, you are not going to earn a lot. But presumably at some point we will have higher rates on CDs and money market funds. Then it may make sense; you may be able to pick up a higher yield by getting some critical mass within one account.

I don't know about you, but I have some cash here and there. In my brokerage account, for example, I like to keep some cash at the ready. But if you do take stock of all those cash holdings and group them together, you may be able to buy yourself some sort of higher-yielding product.

Stipp: Once you get your portfolio organized, your accounts organized, the last step could be to create some kind of master directory or get all your record-keeping in one place and usable should someone else need to look at it. Why is that so important?

Benz: I'm a huge fan of this. I'm a big fan of succession planning for anyone. But especially as people start to edge close to retirement, or certainly if they're in retirement, it make sense to create a document that lays out everything you have, where to go for information about your holdings, passwords, and so forth. And then, of course, you want to then password-protect this document. But put it all together in a single document with account numbers, the person you deal with at a certain investment firm, and so forth, and let your loved ones know of the existence of this document. Maybe let one person know that this document exists and this is where to find everything that we're doing, everything that we hold.

Stipp: Christine, some fantastic and practical tips for our first-quarter portfolio check-in. Thanks for joining me.

Benz: Jason, great to be here.

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

Jason Stipp: I'm Jason Stipp for Morningstar.

As the first quarter is winding down, we're checking in with Christine Benz, our director of personal finance, for some tips on making sure your portfolio is on track--and doing some spring cleaning along the way.

Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: As always with your portfolio checkups, you say start at the general level, the asset allocation level. If I haven't checked my asset allocation for a while, what might I see when I crack open that portfolio?

Benz: You are likely to see higher exposure to equities than perhaps would be your target allocation. When we have strong equity markets, a little bit of inertia tends to set in, and you tend not to want to mess with a good thing if you see your returns going up and up. But chances are, most people's portfolios are pretty equity-heavy relative to their targets if they haven't done anything for the past few years.

Over the past year, even if you had a mediocre domestic-equity fund, it probably returned about 20%. Bonds, you were lucky to earn 2% or 3%. So chances are, things are a little bit out of whack. It calls for stripping back some of the equities and adding to fixed income.

Stipp: So sell some equities if they have gone over my target range and … buy bonds?

Benz: I know. Rebalancing is so counterintuitive, and really everyone hates fixed income right now. But you need to step back and think about why you're owning fixed income in your portfolio. It's not your return engine. Current yields have historically been a pretty good predictor of bond fund returns. At 2%-3% right now, you're not likely to earn great returns going forward.

But what you will have is the potential for much smaller losses or maybe even gains when the equity market goes down. You'll have that ballast. From that standpoint, I think bonds still makes sense, particularly for people who are getting close to retirement or certainly in retirement.

Stipp: Bonds are there to help with diversification. They are to provide ballast. Not necessarily there to be the biggest returning thing in your portfolio?

Benz: That's right. I think you also want to pick your spots within fixed income. Probably most people don't need long-term bonds in their portfolios. Stick with a good-quality, core intermediate-term fund, maybe a flexible fund. PIMCO Total Return has been in the headlines a lot lately, but I still like it. I know [Morningstar fund analyst] Eric Jacobson still likes it. It is a core holding. Harbor Bond, is the no-load analog. Or perhaps look to something like Dodge & Cox Income, where they've got a good value-leaning strategy. Just make sure that your fund is pretty opportunistic and free-ranging. I think that's what you want in a fixed-income market like the current one.

Stipp: That could take a little bit of the edge off if we do see rates tick up.

The next thing is, look at some of the sub-allocations--where your different types of equities are.

Benz: With stocks what we've seen--not so much recently, but certainly when you look out over the past five years--is very strong performance from small-cap stocks. Small- and mid-cap growth stocks, in particular, have notched very strong performance relative to large caps.

Chances are, if you have some of that small-cap exposure, it's probably consuming an outsize stake of your equity portfolio. So, you might think of trimming there and perhaps redeploying those assets into large-cap stocks.

Stipp: What about on the fixed-income side? When I look at the different kinds of bonds I might have, what differences might I see?

Benz: One thing we've seen--and this has really paralleled the equity market rally--is that we've seen some of the more credit-sensitive bonds perform very, very well. Categories like high-yield and bank loans have performed terrifically. Chances are, if people haven't done anything to their bond portfolios, their portfolios are looking somewhat credit-sensitive at this point, given that those positions have probably grown in size.

So here, again, is another time when you may need to hold your nose and redeploy some assets. High-quality fixed-income holdings are probably the ones that need some love in your portfolio, because they are probably underrepresented at this point in time.

Stipp: Here is a tough question that a lot of investors grapple with. The market is up. They look at their portfolio, and their portfolio is up. But how can I really dig beyond that and understand, is it up as much as it could have been or should have been?

Benz: Benchmarking. I think this is such an important thing for investors to do, and I always think that an investor should take a step back if they are in that accumulation phase, look at their returns, ideally track your performance on Morningstar.com, where you've got your holdings in there. Look at your returns and simply compare them to that of a good target-date vehicle. Look at the target-date funds from T. Rowe Price or Vanguard that are geared toward people in your same age band. See how you are doing relative to those set-it-and-forget-it, really easy portfolio holdings. I would start with that as a simple benchmark.

Then I'm also a big fan of the idea of creating a custom benchmark--something very simple, composed of broad plain-vanilla index funds with very low expense ratios. Compare how your own portfolio and its asset allocation does relative to an index portfolio that mirrors your asset allocation. That way you can see if you are adding or subtracting value with your extra efforts. If not, maybe you are better off in the very low-cost vanilla portfolio.

Stipp: Lastly, what are some different ways you can simplify your life and your portfolio as you are doing a portfolio checkup?

Benz: Definitely, and this also ties in with tax time. I think we all have been looking at our documents; we've got them all on the desk. So it's time to look at where you are holding various investments, and think about whether you have opportunities to consolidate. If you're finding that you have to pull from here, there, and everywhere to get your statements together, because you have accounts all over the place, think about whether you might consolidate with maybe one or two very good providers.

This will give you a couple of opportunities: One is less oversight on an ongoing basis of your portfolio, so that's valuable. You may also be able to qualify for lower-expense share classes than you would by having smaller pools of assets all over the place.

The other thing a lot of firms are offering these days is at least some advice for people who have significant assets at the firm. So you might qualify for some tier of advice. Even if you're a dedicated, do-it-yourselfer, it's not a bad idea to get a second set of eyes on your plan, just to get a second-check on what you're doing.

Stipp: What about some funds that might overlap with other funds? How can I get a handle on that, because it seems like that would be a great area to streamline for my own time management, but also for my portfolio?

Benz: That's right. I feel like I'm always beating this horse about the issue of very narrowly focused holdings that investors tend to gravitate to. Right now, for example, I'm hearing about Fidelity Biotechnology everywhere I go. Whatever sector has been hot, people tend to want to buy. What ends up happening is, over time people end up with these little specialized holdings that maybe they really don't need in their portfolios.

If they have broadly diversified core holdings, they probably don't need individual sector funds. I don't think that most investors need region-specific funds, unless for some reason they want to own a fund by a specialist like Matthews in Asia--that's sort of a rarity. But for the most part, people don't need a lot of these specialized exposures. They'll do just fine owning broadly diversified funds, which also tend to have lower expense ratios than some of these more specialized investment types.

Stipp: For most investors, these specialized funds are a small part of their portfolio anyway, and as you said, probably duplicating some of the holdings in their core accounts.

You say also that consolidating your cash accounts can actually have a little bit of a lift on the yield side.

Benz: Potentially. Right now, nothing really matters with cash. No matter where you park your money, you are not going to earn a lot. But presumably at some point we will have higher rates on CDs and money market funds. Then it may make sense; you may be able to pick up a higher yield by getting some critical mass within one account.

I don't know about you, but I have some cash here and there. In my brokerage account, for example, I like to keep some cash at the ready. But if you do take stock of all those cash holdings and group them together, you may be able to buy yourself some sort of higher-yielding product.

Stipp: Once you get your portfolio organized, your accounts organized, the last step could be to create some kind of master directory or get all your record-keeping in one place and usable should someone else need to look at it. Why is that so important?

Benz: I'm a huge fan of this. I'm a big fan of succession planning for anyone. But especially as people start to edge close to retirement, or certainly if they're in retirement, it make sense to create a document that lays out everything you have, where to go for information about your holdings, passwords, and so forth. And then, of course, you want to then password-protect this document. But put it all together in a single document with account numbers, the person you deal with at a certain investment firm, and so forth, and let your loved ones know of the existence of this document. Maybe let one person know that this document exists and this is where to find everything that we're doing, everything that we hold.

Stipp: Christine, some fantastic and practical tips for our first-quarter portfolio check-in. Thanks for joining me.

Benz: Jason, great to be here.

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