Simplifying Your Portfolio for Your Spouse

Note: This video is part of Morningstar's October 2014 5 Keys to Retirement Investing special report.

Jason Stipp: I'm Jason Stipp for Morningstar. A big part of estate planning is thinking about your investment portfolio and how that portfolio may need to transition to your spouse. Joining me with some tips on that is Morningstar's Christine Benz, our director of personal finance. Christine, thanks for being here today.

Christine Benz: Jason, it's great to be here.

Stipp: One of the issues that we know among our readers is this issue of "Maybe I have a spouse who is not as engaged in investing as I am." That could have some implications for how you might want to formulate a portfolio that may eventually pass to that spouse.

Benz: This is such an important topic, and this is a profile that we've identified among so many of our users who are actively engaged, hands-on investors; oftentimes, when I talk to those investors, they say, "My spouse just isn't into this stuff." So, it's important, especially if you're the older partner in your relationship, to start thinking about how you can build a portfolio that your spouse could easily manage even if you were unable to do it for whatever reason.

Stipp: One of the big parts of that might be excising some holdings from your portfolio. What kinds of things might you want to take out in that case?

Benz: I think any narrowly focused fund type would go on my chopping block. So, these would be region-specific or sector-specific funds, funds that just take a small cut of the market. I might also look at individual stock holdings. As much as I like the idea of building a high-quality portfolio of individual stocks, if your spouse isn't up for ongoing oversight responsibilities, they probably will not want to have to manage individual stock constituents.

I'd also think about excising any sort of tactical strategies that you might be implementing in your portfolio. Sometimes, I talk to retired people who say, "Well, anytime the Dow Jones Transportation Average moves above this level, I do blah-blah-blah." That's the kind of strategy that is better left to someone who is comfortable with it. It's not the kind of thing that you want to try to teach to a spouse who is not particularly engaged in investing.

Stipp: There are also some core, key types of funds that can be harder to hold.

Benz: That's right. So, I would think of funds that aren't particularly representative of a broad swath of the market. Maybe they use narrowly focused strategies and maybe they are volatile. So, they might be diversified funds--not sector funds or anything like that--but here I'm thinking of, say, Fairholme fund (FAIRX). It's a very idiosyncratic strategy. Longleaf Partners (LLPFX), one that I hold. They're very good funds, I think, for investors with long time horizons, who have a lot of tolerance for short-term volatility. They might not be the kinds of things that a novice or a non-interested investor might have a great comfort level with.

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Stipp: When those funds get volatile, it's easy to make mistakes as a fundholder of those funds just because it's so stressful sometimes to hold them.

Benz: Exactly.

Stipp: So, if those types of funds might be coming out, what kinds of funds might go in for this portfolio?

Benz: I think you want to think about how you can get as much diversification as possible in a single shot. So, certainly, broad market index funds come to mind, whether a stock or bond. And here, I think it can be as simple as just picking three index funds and segmenting them based on your asset-allocation parameter. So, you might have the fixed income. You might have domestic equity, international equity. That's one of the easiest ways to skinny down a portfolio. But it doesn't have to mean index funds. I think you could also use high-quality broadly diversified funds as well, actively managed funds. We often talk about Vanguard Dividend Growth (VDIGX) as being a good example of an actively managed fund--kind of a conservative cut of the broad market. So, I think you can think about a few different strategies.

Stipp: Could you get even simpler and have more of an all-in-one option?

Benz: Potentially so. This gets a little bit more tricky, though, if you are trying to extricate cash from the portfolio on an ongoing basis. But you could certainly think about having some sort of a balanced portfolio, Dodge & Cox Balanced (DODBX) is one that we've really liked a lot over the years; Vanguard Wellington (VWELX) is perhaps another idea, a little more equity heavy. But you could potentially get away with a single fund.

Stipp: So, you mentioned there that, in some cases, these portfolios are in withdrawal mode or there will be cash that needs to come out of them. How should I think about this if I do have a portfolio that's providing some part of living expenses and I do want to pass that along to a spouse?

Benz: I think it's important to step back and strategize about this. How can we make sure that the near-term cash flow needs are met without a lot of moving parts. One of the easiest ways to do that is to simply set up that bucket number one--so, one to two years' worth of living expenses in true cash instruments--and then set up a mechanism so that your dividend and income distributions are coming straight over into bucket one on an ongoing basis. So, your spouse isn't going to have to lift a finger to get most of his or her cash flow needs met. I think that that can be a nice setup.

I also like the idea of these relatively new managed-payout funds. They're not looking strictly for income distributions to meet their payout. Instead, they might be using rebalancing proceeds. They can be a little bit flexible about where they come up with their payouts. I like that strategy as well. You could have those payouts spilled directly into bucket number one as well.

Stipp: Christine, this is a very important topic for our readers and their spouses. Thanks for joining me in those tips today.

Benz: Thank you, Jason.

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