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4 Signs You May Need a Portfolio Makeover

Jason Stipp
Christine Benz

Jason Stipp: I'm Jason Stipp for Morningstar.

Christine Benz, our director of personal finance, will be making over five portfolios June 2-6 as part of our Portfolio Makeover Week. If you weren't one of the lucky ones to get a portfolio makeover this year, she still has some tips on when you might want to do a makeover yourself. She is here to share those today.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: One of the first problems that you see when you get portfolio makeover requests is portfolio sprawl. How bad is sprawl among some of the makeover requests that you've seen?

Benz: This is the most frequent problem that I encounter. People will send in their Excel spreadsheets with their portfolios, and it's not unusual to see 70 or 80 holdings, and it's easy to see why this happens. People have multiple account types. They might have IRAs and 401(k)s, and if you have two spouses in a household, both of whom are saving in their respective accounts, you can see those number of holdings compounded even more.

This is a big issue. It's one that I always try to address when I do portfolio makeovers.

Stipp: What are some of the problems that can arise when you have so many holdings?

Benz: A couple of the big ones. One is just the oversight responsibilities when you have many different holdings to stay on top of. This is particularly an issue where you've got individual stocks, which require more oversight on a regular basis, as well as actively managed funds, where you've got to keep an eye on the manager, the structure of the fund company, and so forth.

It can be an issue when you've got too much to keep track of, too many statements flowing into the house or into your email box. It can be difficult from an oversight standpoint.

Stipp: If you have a lot of holdings, you could own most of the market, but you might be paying more fees than you need to for such an overall portfolio.

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Benz: That's exactly right. I'm encountering a lot of portfolios, especially in this go-round, where we're seeing a lot of sector-specific exchange-traded funds, maybe covering the whole market in terms of the exposures, but the total portfolio in many cases is very index-like. So, I look at something like that and think, well, is it possibly simpler to achieve this general investment complexion by using fewer holdings? Oftentimes it is.

Stipp: And if you have a lot of active managers and they're overlapping each other and the market, you might be paying active management fees for an overall portfolio that, at the end of the day, is more like an index.

Benz: Exactly. That's a big concern if you have actively managed funds or even sector-specific ETFs, which sometimes charge more than you would pay for a total index tracker. Keeping costs down is a consideration, too.

Stipp: And there is also a tendency, if you have all these little moving parts, to go in and tinker.

Benz: That's my concern, especially when I see a lot of sector- or region-specific investments. My concern is that temptation might be there to, say, downplay China right now and add to India, or make some other tactical adjustments that may, in hindsight, not have been particularly well-timed.

Stipp: What are some of your solutions when you see portfolio sprawl?

Benz: If we have multiple account types of the same variety--so for example, if we have a rollover IRA and a traditional IRA--is it possible to consolidate with a single investment provider?

I also look for duplication among holdings. For example, if both spouses have major allocations to some sort of core fixed-income vehicle in their 401(k)s, but one spouse has the much better option, maybe we put much more of her account into that better bond fund and short shrift it in the other account.

I also look for cases where perhaps we can get away with maybe a single index fund in lieu of many different individual stocks or sector-specific ETFs.

Stipp: Portfolio sprawl is the first big warning sign that you might want to undertake a portfolio makeover.

The second one is if you just haven't checked your portfolio or your allocations for a while. Maybe you made some moves during the market volatility a few years ago, but the markets have also moved a lot. So, if you have some concerns, or you're not quite sure where you are, it could be time to open the hood.

Benz: Absolutely. It's worth revisiting your asset allocation every year or so. And I am happy to say that as I go through these portfolio reviews, I'm hearing less from people who say, I got very defensive during the bear market; I'm not sure how to get back in now that the market has gone up a lot. I'm hearing less from people like that, which is good, but it's still worthwhile to check up on that asset allocation, which, of course, will be one of the main determinants of how your portfolio performs over time.

See how your portfolio stacks up relative to, say, benchmarks such as Morningstar's Lifetime Allocation Indexes. Run through some portfolio software, or use some sort of asset allocation software, to see if you're in the right ballpark and see if you need to make some adjustments.

Even if you've done nothing to actively alter your asset allocation, the market has altered it. So, generally speaking, if people have done nothing since we came out of the bear market, their portfolios might be looking heavier on equities than would be ideal given their life stages.

Stipp: What if my portfolio is looking heavier on equities? What should I do about it, given that the bond market also doesn't seem like the best place to put a lot of money right now?

Benz: The problem is stocks are not particularly cheap. I don't think they're egregiously overvalued, based on our stock analysts' bottom-up view, but they're not cheap, either.

I think dollar-cost averaging is always a sensible strategy, but particularly in markets where neither asset class looks to be a screaming buy. I would say the same is true for investors who do think that their portfolios are equity-heavy and perhaps need to move some money into bonds. There again, you'd want to dollar-cost average into bonds.

Stipp: What if I'm very heavy on equities and I'm getting close to retirement?

Benz: Well, that's a different story. I have written about this issue before, and I think it makes sense to de-risk immediately. Take the money out of stocks and perhaps move it into cash, and then dollar-cost average into bonds over a period of months or, if you're dramatically underweight bonds, perhaps over a period of years.

Stipp: So the second sign is, if you haven't revisited your allocation in a while, the market itself can cause shifts there, and it could be time to do a makeover.

But there are also other events, life events, that might cause you to adjust what your targets are or to set a different kind of allocation than you've used for the past few years. What are some of those signals that it's a good time to open the portfolio and check those allocation targets?

Benz: One big one, Jason, would be if someone has changed jobs recently and has rolled over assets from a 401(k) plan into an IRA. That's a great time to check up on the portfolio's overall allocations and perhaps correct some of those portfolio imbalances by making changes within that new rollover IRA.

Recently married couples who are combining finances will also want to do an X-Ray view of their total portfolio, assuming they plan to manage those assets together. That's a great time to get in there and look at each spouse's 401(k) options, for example, and there I think it does make sense to have a "take the best, leave the rest" approach. Make sure that you are using the best-of-breed options within each spouse's 401(k) plan.

Stipp: If you get an inheritance, that could change the profile of how you might save and what kinds of investments you would own.

Benz: Absolutely. That's a great time, first of all, to look at the rules regarding what types of assets you inherited. There are some tricky rules regarding inherited IRAs, so make sure that you're following those to the letter. But also take a look at your total portfolio and perhaps make some adjustments based on the nature of the assets that you've inherited, as well as the assets that you had before.

Stipp: The last sign that you might want to do a portfolio makeover is a sub-set of life change, but it's the big one--approaching retirement. That's definitely a time to look at your portfolio. It may need some kind of makeover.

Benz: Absolutely. We touched briefly on how asset allocation changes are often in order when you get close to retirement, but you want to specifically look at liquidity in that portfolio. Look at where you will go for cash on a regular basis. Do you have that liquidity in place in your portfolio?

As you know, I'm a big believer in the bucket strategy, where you've got a cash bucket carved out of your portfolio that is there to meet near-term living expenses. I think it's a really sensible strategy. You want to think about having one to two years' worth of living expenses in that cash bucket.

Also think about being tax-savvy when tapping that portfolio in retirement. Make sure that as you pull assets from your portfolio, you're trying to stay in the lowest possible tax bracket.

This can be a great time to check in with a tax professional to help you strategize about where you will go for cash on a regular basis.

Stipp: On the point of strategy, you just say it's important to have one. Go into retirement and know what your strategy is for income, so that you're being consistent in how you're managing the portfolio.

Benz: That's right. I think it can be very clarifying to step back and think about what strategy you are using for extracting money from your portfolio. Really, there are just a few key ways for doing this.

One is a very income-centric strategy, where you're going to focus on income-producing stocks and bonds and try to get your living expenses that way.

Another strategy, and the one that I would probably favor more, is a total return approach, where we're managing this portfolio for the best possible return. We're managing a balanced portfolio, and we'll use rebalancing to help shake out money for living expenses.

I also hear from readers and viewers who say that they're using an opportunistic combination approach. So maybe they're using those income distributions and seeing how far those distributions will get them, but then for any additional expenses, they're perhaps using rebalancing to help fill up their bucket number one.

You can do it a few different ways. Just understand and have a strategy for how you will meet your living expenses.

Stipp: Christine, your makeovers have helped investors have all stripes and all life stages. I'm looking forward to seeing this year's makeovers. Thanks for joining me today.

Benz: Thank you so much.

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