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Your Financial To-Do List for July

Is it raining or too muggy? Use this time to evaluate your portfolio.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. July is peak vacation season. But if you find yourself with a bit of free time, Morningstar's director of personal finance, Christine Benz, has some financial jobs that you can tackle this month.

Hi, Christine. Thanks for being here today.

Christine Benz: Hi, Susan. Great to see you.

Dziubinski: Now, we're halfway through 2021 already. And you think that it's a good time for investors to do a little bit of a checking up on their portfolio and their plans midyear. Where should they start?

Benz: Well, with the usual things, and there, I would say you'd want to put at the top of the list some sort of wellness check. You'd want to see whether your savings rate is on track given when you hope to retire or if you're already retired. Do a little bit of a check on how your spending looks for the year-to-date. We have seen people get out there and begin spending more money recently. Consumers are really eager to get going. So I think it's crucial to sort of take a step back and look at whether your overall plan is on track--start there. Also look at your portfolio's asset allocation, we have gotten off to a pretty good start so far in 2021 in terms of equity market return. If you haven't checked up on it recently, check up on whether you might need to do a little bit of adjustment to potentially bring down your equity exposure and add more to safer securities, which haven't performed as well. And then if you have time, I think it also makes sense to take a look at your holdings--make sure that nothing material has changed with your mutual funds or your ETFs. Certainly if you're an individual stock investor, you'd want to check up on the fundamentals of those holdings and make sure that they're still intact, and make sure that your overall positioning makes sense given where you are in your proximity to retirement.

Dziubinski: You also suggest that investors perform a cost audit as part of a midyear portfolio review. First, can you discuss why in particular you think it's important to pay attention to the total investment-related costs of your portfolio?

Benz: Absolutely. We're always evangelizing about the importance of limiting investment-related costs. But I would say, more now than ever, it really makes sense to take a look at what you're paying in investment-related fees. And the reason is that when we look at starting bond yields as well as starting equity valuations, they suggest that returns for stocks and bonds over the next decade could be constrained. And so to use a simple example--let's say that you have a 4% return on a balanced portfolio over the next decade. If you are paying 1% in terms of all-in investment costs, you're effectively ceding 25% of your return right there. I think it makes sense to be very parsimonious about what you're paying in investment-related fees, particularly given that returns may not be so great in the future.

Dziubinski: Now, if an investor does want to do a cost audit of his or her portfolio, what should be on their dashboard?

Benz: Well, certainly taking a good look at the investment-related costs that you're paying. This is one reason we've seen these tremendously strong flows going to very inexpensive index funds and exchange-traded funds--because investors recognize the role that costs play in their take-home returns. Start with your investment costs. You can find a view of what you're paying in terms of your asset-weighted expenses if you use the X-ray feature of Morningstar.com's Portfolio Manager. Also take a look at what you're paying in advisory fees. Oftentimes, the fees that investors pay to their advisors are money well spent. The advisor can help keep you in your seat in those periods of market duress. But make sure that you're not paying for advice that you're not necessarily using. So, take a look at your advisory fees as well as part of this cost audit.

Dziubinski: Another part of a midyear portfolio review that you suggest is conducting a tax audit. Why is this important? And what would it involve?

Benz: Right. In a similar vein, you look at your before-tax, before-expense return, well that gets reduced by fund expenses, by tax costs. So, it makes sense to take a look at what you're paying in taxes. And I would split this into really two categories. One would be to make sure that you are making the maximum allowable contributions or at least as much as you can swing into the various tax-advantaged receptacles that you have available to you. That might be some sort of company retirement plan, it might be an IRA, health savings accounts might be available if you are covered by a high-deductible plan. Very high-income investors may find that they have even more to invest in there; you may want to see if your plan--your company retirement plan--offers what are called "aftertax contributions." So make sure that you're fully funding and fully taking advantage of all those tax-advantaged savings receptacles. If you're saving for college, look at 529s.

And then within your nonretirement non-tax-advantaged accounts, do a quick look at those to make sure that you're investing as tax efficiently there as you possibly can. This is another feather in the cap of exchange-traded funds and index funds: They tend to be very tax-efficient, at least equity ETFs and index funds. If you're a higher-income person and have fixed-income assets in your portfolio, you may also want to look at municipal bonds. So take a look at that portion of your portfolio. Your 2020 tax return may be a good guide to where you may be able to make some adjustments to make your portfolio more tax-efficient going forward. Just bear in mind, though, that in order to engineer some of these tax-efficient maneuvering, you may trigger some other taxes. So get some tax advice unless you're completely comfortable with tax-related matters.

Dziubinski: Christine, we've been hearing about some proposed tax law changes that could have implications for investors. Is there anything they should be thinking about or doing pre-emptively?

Benz: Well, if you have highly appreciated positions in a taxable account, I do think it's a good time to get some tax advice about how to proceed. It sounds like the changes under consideration, which would involve a higher capital gains rate on the highest-income investors as well as potentially a little bit of a curtailment of the step-up in cost basis that's currently available for inherited assets, those would be the two main changes. So get some tax advice if you have highly appreciated positions in your taxable account and think that you may be vulnerable to some of these changes. It may be that if you take a close look at the situation, those highly appreciated positions are also adding risk to your portfolio. They're skewing your portfolio heavily to perhaps company stock. I do think it's a good good time, especially considering where we are in the market cycle, to consider whether you could potentially reduce your overweighted positions and do so in a tax-efficient manner. Perhaps in a series of sales over a series of years. There may also be a role for charitable giving in relation to those positions. It is a good juncture to get some tax advice in light of the potential tax changes, as well as in light of the fact that we have had such a long-running rally in equities.

Dziubinski: Christine, thanks so much for giving us something to do in July if we didn't have something to do. We appreciate your time.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.