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Portfolios

A One-Stop In-Retirement Portfolio-Maintenance Regimen

The following six steps tie together portfolio maintenance and rebalancing, RMDs, and more.

I sometimes run into retired investors who tell me that overseeing their portfolios is their new full-time job. I don't doubt that for many retirees, investing is a hobby, a passion, or both; it's only natural that such engaged investors devote a fair amount of time to what they enjoy. Moreover, investors with more hands-on strategies, such as investing in individual stocks, may well need to devote a fair amount of oversight to their holdings.

But for retired investors who would rather not spend hours overseeing their portfolios and figuring out how to wring income (er, cash flows) from their portfolios, I'd argue that it's possible to distill in-retirement portfolio maintenance into a single cohesive regimen that can be conducted toward the end of each year. Such a one-stop review ties together portfolio maintenance and rebalancing, meeting RMDs, and replenishing liquid reserves. Because these activities are related, it only makes sense to tie them together into a unified process. Depending on the complexity of the investor's portfolio, such a holistic regimen can be conducted in just a few hours.

If you're interested in streamlining your portfolio-maintenance obligations, here are the key steps to take. A few quick notes/disclaimers before we get started: The following assumes that the retiree has a handle on portfolio basics, such as a sensible asset allocation and a sustainable withdrawal rate. It's also assuming that a retiree is using the "bucket approach" to portfolio management, essentially teeing up a year or two of cash needs pre-emptively each year. It's assuming that a retiree is reinvesting income and capital gains distributions and is using a "strict constructionist" total return approach to retirement-portfolio maintenance, meeting cash-flow needs with rebalancing alone; a retiree relying on ongoing income distributions for all or part of living expenses may well have less of a need to rebalance than discussed here. Finally, the below regimen doesn't encompass every worthwhile component of in-retirement portfolio maintenance, including tax-loss selling or charitable giving.

Step 1: Check up on how your spending is going for 2016. The first step in any portfolio review and maintenance process is a basic wellness check: Is your portfolio on track to meet your goals? If you're retired, the key metric to stay on top of is your spending rate: What percentage of your balance will you spend in 2016, and is that amount in line with your targets? Divide your 2016 spending by your balance to arrive at your withdrawal rate.

If you're conducting your portfolio review this early in the year, you still have time between now and year-end to course-correct by reining in spending during the year's last three and a half months. If you're conducting your review toward the very end of the year, your only recourse may be to ratchet down your spending next year. (It's the financial version of eating light in the days after New Year's because you gorged yourself over the holidays; it's necessary and it might even feel good.)

Step 2: Determine next year's portfolio cash flow needs. The next step in the process is to determine your spending needs for next year, above and beyond what you expect to receive from certain sources of income such as Social Security, a pension, or an income annuity. That's the amount you'll need to take out of your portfolio; before you go any further, make sure that the withdrawal amount is sustainable.

If you're currently post age 70 1/2 and are required to take required minimum distributions, go to Step 3. If you're not yet subject to RMDs, skip ahead to step 4.

Step 3: Assess current-year RMD requirements (if any). Next, if you're age 70 1/2 or older, assess your required minimum distribution amount for the 2016 tax year; this amount must be removed from your RMD-subject IRA and company retirement plan balances by Dec. 31 of this year. Your RMD amount is based on your IRA and company-retirement plan balances at the end of 2015. You must calculate an RMD for each account using the IRS' tables; you can then add those amounts together to arrive at your total RMD. That amount can come out of a single holding; you don't need to take a cut from each of your holdings. Document this amount; this is what must come out of your IRA and/or company retirement plan by year-end. (Note that you cannot take a single RMD for multiple accounts of a different type, such as an IRA and 401(k); you must calculate and take a separate RMD amount from each account.)

If your RMD amount is insufficient to meet your 2017 cash-flow needs (the money you'll use to refill "bucket 1"), you'll need to withdraw from other parts of your portfolio, such as your taxable accounts. Move on to Step 4.

If your RMD amount is sufficient to meet all of the 2017 cash-flow needs you identified in Step 1--and perhaps it's higher that--move on to Step 5.

Step 4: Assess other sources of cash flow, if needed. If you're not yet subject to RMDs or if your RMDs are insufficient to meet your cash-flow needs, take stock of your various accounts and your current tax position to determine where best to draw additional income from. This can be complicated if you're not well versed in the tax code and the tax treatment of various account types, so it can be a money (and time) saver to seek assistance from a tax-savvy financial advisor or investment-savvy tax advisor.

If you find yourself in a particularly high tax year--because you have few deductions, for example, or you sold stock at a big profit--you may have good reason to favor accounts where withdrawals carry relatively light tax consequences, such as Roth IRAs or taxable brokerage accounts. (In-retirement withdrawals from the former aren't typically taxed, whereas withdrawals from the latter will often be eligible for capital gains treatment, currently as low as 0% for some investors.)

If, on the other hand, you expect to be in a low tax year due to low earnings, high deductions, or some other confluence of events, it may be wise to prioritize withdrawals from a traditional tax-deferred account such as an IRA. Withdrawals from such accounts are taxed at your ordinary income tax rate, so it's better to take the tax hit on those withdrawals when you're in a low tax bracket for the year.

Step 5: Conduct a portfolio review. The next step in the year-end portfolio-monitoring process is to conduct a portfolio assessment. That, in turn will help you figure out where to take those withdrawals from (or, if your RMDs exceed your income needs, where to reinvest).

To help simplify the process, my advice is to maintain separate sub-portfolios in Morningstar.com's Portfolio Manager for each account--one for your IRA, one for your taxable assets, one for your Roth IRA, and so on. (You can readily combine those sub-portfolios--using the "Combine" feature--for a holistic view of your asset allocation.) If you don't have a portfolio saved on Morningstar.com, entering your portfolio via Instant X-Ray is an easy way to accomplish that; just click "Save as a Portfolio" after entering your holdings.

You can then use Portfolio Manager's X-Ray functionality for a look at the asset allocations and other key metrics for each of those sub-portfolios. That information can help you determine where to withdraw or reinvest to help correct any issues you identify.

As you conduct this review, take stock of the following aspects of your portfolio:

• Asset allocation relative to your targets • Positioning within the Morningstar style box ("Neutral" is roughly 25% in each of the large-cap squares; 7% apiece in the mid-cap squares; and 3% in each of the small-cap squares.) • Sector positioning relative to the S&P 500 • Fixed-income positioning: Is your portfolio overdoing higher-yielding, higher-risk credits? • Stock- or fund-specific problem spots, such as overconcentration, manager changes, and the like.

Step 6: Determine where to withdraw/reinvest based on above assessment. The review in Step 5 can go a long way toward helping you determine where to pull your withdrawals from or, if your RMDs exceed your needed withdrawal, where to reinvest.

Say, for example, your target asset allocation is 50% stocks/50% bonds, but your IRA portfolio is currently 60% equity/40% bonds. To meet your RMDs, you'd naturally pull them from your most highly appreciated equity holdings within your IRA.

On the flip side, if your RMDs exceed your cash-flow needs and, more important, will take you over your sustainable spending rate, you'll need to figure out where best to reinvest them to improve your portfolio's risk/reward profile. You can't reinvest them in your traditional IRA but you can plow them back into your taxable account, or even move them into a Roth IRA, provided you or your spouse have enough earned income to cover the contribution amount. Here, you'd identify the areas of your portfolio that most need topping up--in the case of the 60% equity/40% bond portfolio, the RMDs might come out of equities and any overage could go into bonds within the taxable or Roth account. (If you're adding bonds to your taxable account, municipal bonds may be a fit, depending on your tax bracket.)

While bringing your portfolio's asset allocation back in line with your targets will have the biggest role in how it behaves, asset allocation shouldn't be the only factor you keep an eye on. You can also address other problem spots in your portfolio--even if your equity weighting isn't too large, for example, your weighting in a given fund may be, or perhaps you've been meaning to swap more of your actively managed funds in your taxable account for ETFs.

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