Investing Insights: A Midyear Portfolio Checkup in 5 Steps

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Christine Benz: Hi, I'm Christine Benz and welcome to our special webinar for Morningstar.com premium subscribers, "A Midyear Portfolio Checkup in 5 Easy Steps." Over the next hour, I'll be walking you through how to evaluate your portfolio and decide if any adjustments are in order. My colleague, Jeremy Glaser, will be joining me later on to help tackle some of your questions. If you'd like to submit one, please email us at miic@morningstar.com or by clicking the link above the player. If you'd like a copy of my slides, please download them from the link above. We'll be recording this presentation, and we'll make it available at this link within the next 48 hours.

Before I get into the midyear portfolio checkup, I'd like to just spend a little bit of time recapping the first half in market action. In terms of equity performance, as we investors know, we saw the recurrence of volatility in the first half of 2018. We had a little bit of interest-rate related volatility in the March and February period. Then more recently, we had some concerns about trade-related issues and we experienced a little bit of volatility in the market then as well.

Most large-cap finds finished the midyear point with slight gains, but we saw a distinct bifurcation in terms of what performed well and what didn't. We saw growth stocks generally continuing to outperform and that's been part of a long-running trend. I'll touch on the importance of that when thinking about your portfolio later on.

Small-cap growth was the best-performing style box square, gaining about 11%. Large-cap value brought up the rear in the first half of 2018, losing just a little bit during the period. It's been a long-running dark night for large-cap value stocks. It's been part of a persistent trend. In terms of the best-performing sectors, as you might expect, given that we saw growth stocks perform generally pretty well, the technology sector continued to lead the way. Healthcare stocks also performed particularly well. Gold stocks, precious metals equities, continued their slump, losing about 7% in the year's first half.

In terms of international equities, what we saw was that international equities performed OK when denominated in their home currencies. But when those gains were translated into dollars, we saw slight losses for most foreign stock funds. Emerging-markets equities performed particularly poorly during the year's first half, losing about 7% on average, diversified emerging-markets equities funds.

In terms of what went on in the bond market, we also saw volatility there and specifically, interest-rate related worries jolting bonds and bond funds in the first half of 2018 and the first quarter in particular. As you might expect, given that we saw the Fed raising interest rates during this period, long-duration bonds performed the worst among the various bond categories, and short-term bonds held up relatively better and that's typically the performance pattern we see when the Fed has embarked on a rate increase pattern.

In terms of other bond categories, emerging-markets bonds performed particularly poorly and that's something we often see when interest rates are on the move in the U.S. Investors say, if higher yields are coming available for safer bond types, I would prefer to pick up my higher yield there rather than endure the volatility that typically accompanies emerging-markets bonds and other risky bond types. We also saw the dollar's appreciation relative to developed markets and developing markets foreign currencies and that played a role as well.

In terms of the best-performing bond market sectors during the first half of the year, bank loans continued to perform quite well, and this is to be expected in a period of rising yields. We typically consider this category to be somewhat impervious to interest-rate changes because the yields on these securities reset to keep pace with prevailing bond market yields. they tend to be a good asset class to own in a period when interest rates are trending up.

The ultrashort bonds category, it's quite a small category but that too performed quite well. These are funds that are just a step away from money market funds in terms of their interest-rate sensitivity. We saw that they generally held their ground quite well during this period. The worst performers, I've touched on a couple of the problem spots. Long-duration bonds were a problem. Emerging-markets bonds were a problem, especially those denominated in local currencies versus dollar-denominated emerging-markets bonds.

Somewhat surprisingly, we saw municipal bonds hold up OK during the first half of 2018. I think that's because investors remain generally pretty sanguine about the outlook for municipalities across the U.S. With the exception of a few high-profile problem children investors are looking to municipal finances and see them generally maintaining their strength. Municipal bond high yield credits performed particularly well during the first half, gaining about 1.5% during the period.

In terms of portfolio checkups, generally before we get into the five steps to think about when conducting your own portfolio checkups, first of all, I would say, whenever you're conducting a portfolio checkup, less is more. For most investors, I think, a quarterly checkup is more than enough. You may want to do a semiannual checkup or perhaps an annual checkup. But any more frequent checkups than that, I think you run the risk of getting in there and making trades that in hindsight you would rather not have made. I'm a big believer in Vanguard founder Jack Bogle's mantra of not peeking at your portfolio to the extent that you possibly can. Of course, if you're an individual stock investor, you may have a need to get in there and pay a little more attention to what's going on with your holdings. But certainly, if you are a mutual fund investor or an ETF investor, I think a quarterly checkup, or a twice yearly checkup is more than enough in terms of checking up on your portfolio.

When checking up on your portfolio, I also think it's a great idea to stay focused to the extent that you possibly can. I know it's easy to get distracted by, first of all, the headline number if your balance has been improving, but also which holdings have been performing best or worst. I think it helps to go in with some sort of an outline or a checklist to help guide your activities. And that's the focus of the presentation today--to help you find a short list of factors to home in on as you conduct your portfolio checkup.

I think it's also valuable to start with the most important issues and then progress to those that are smaller-bore or perhaps less impactful in terms of how your portfolio behaves. That's how I have organized the presentation today.

I think it's also valuable to focus to the extent that you possibly can on your overarching strategy and try to focus a little less on the performance of underlying holdings. And finally, if you run through a portfolio review and determine that it's time to make some changes in your portfolio, it's really valuable to take any transaction costs that you'll incur into account and also factor in any tax costs. That's why when we talk about rebalancing or making changes to a portfolio, if you have tax-sheltered accounts, whether traditional tax-deferred or Roth accounts, it's best to concentrate your rebalancing activity there and not touch your taxable accounts unless you absolutely have to. Because you'll typically incur some tax costs to make changes. That's particularly true today given that we've had such a long-running appreciation in the equity market. Most investors have gains in their equity holdings. to make changes to those holdings, that could entail tax costs if you're making those changes in your taxable accounts.

In terms of the portfolio checkup process itself, I put the checkup process into five key steps. The first step is to conduct a wellness check. Simply ask and answer the question, is my plan on track given my life stage, given my proximity to retirement. I'll talk about how to ask and answer those questions depending on your life stage.

The next step is to assess your portfolio's asset allocation and you can use Morningstar's X-ray tool to get a very specific read on your asset allocation. You then want to compare that to your targets.

The next step is to go a little smaller-bore. Once you've evaluated your asset allocation, to take a look at any inadvertent bets that might be lurking in your portfolio. Perhaps, your portfolio has a big bet on growth stocks, or maybe you have significant home country bias in your portfolio and you're a young investor and your aim was to have a globally diversified portfolio. You want to troubleshoot those subasset allocation level risk factors in your portfolio.

The next step is to review your individual holdings. Certainly, if you're a Morningstar premium subscriber, you have great tools to do that. You have the Analyst Ratings for individual stocks, for mutual funds, for exchange-traded funds. You also have the analyst reports that you can lean on to evaluate whether your holdings are in line with what you hope them to be.

Finally, the last step in the portfolio checkup process is to think about your action plan for the second half of 2018. Toward the end of the presentation, I have a few guidelines when thinking about your to-do list for the second half of the year.

In terms of the wellness check, if you're an accumulator, if you're someone who is saving for retirement, the headline number that you want to focus on is your savings rate. Look at where you are in terms of how much of your income you are setting aside each month or each year. If you are in accumulation mode, I would set 15% as a good target savings rate for all of us, at a minimum. But if you are a higher-income investor, you probably want to target an even higher savings rate than that, so ideally, 20% or even higher. And the reason why you can afford to stretch a little further in terms of your savings rate is that you should have more discretionary income. And then also when you are retired, Social Security is going to step up and provide less of your income needs than is the case for people who have lower or middle incomes. You want to target a higher savings rate if you are a high-income earner.

I have included on this slide some savings benchmarks that you might reach for based on your life stage. I cobbled these together based on some longstanding research that Fidelity Investments has put out as well as the more recent work from T. Rowe Price Investments. These are just some benchmarks that you can use to help gauge your progress as the years go by based on your own life stage.

I think it's also valuable in addition to looking at those very loose rules of thumb for savings benchmarks to also take a step beyond them if you're an accumulator and use some sort of an online calculator to determine whether your retirement plan or your plan for whatever you're accumulating assets for is on track.

A couple of retirement calculators I like and often refer to are Vanguard's retirement nest egg calculator. This is kind of a quick and dirty tool that will give you an idea of your savings progress, whether your portfolio today puts you on track for your expected in-retirement income needs. T. Rowe Price's retirement income calculator is another calculator that I have long recommended. It's quite holistic. It takes into account the tax character of your various investment accounts. It takes into account Social Security. It is a well-rounded tool for gauging the viability of your portfolio and it's useful whether you're in accumulation mode or whether you are someone who has already started retirement and you've begun drawdown mode.

If you're using any sort of retirement calculator, look for tools that are as holistic as possible, so those that factor in all of your assets, ideally those that factor in the role of Social Security and the role that it will play in your retirement plan. You want to think about reasonable return expectations for various asset classes and you also want to make sure that you're incorporating inflation into whatever you're doing in terms of evaluating the viability of your retirement assets.

In terms of how near-retirees or retirees can think about evaluating whether their plans are on track, well, for them the headline number is their withdrawal rates. To arrive at a withdrawal rate you first need to start with your income needs, your expected income needs in retirement. You are then subtracting out whatever of those income needs are going to be met through certain sources of income, nonportfolio sources of income, so assets like Social Security or a pension that you'll be bringing into retirement.

The amount that's left over is the amount of your portfolio withdrawal and then you want to go ahead and calculate a withdrawal rate based on your portfolio balance. You simply would divide your year one portfolio withdrawal by your current portfolio balance to determine your withdrawal rate. Once you've come up with your withdrawal rate, it's time to think about whether that is a sustainable withdrawal rate. As many of you know, who are steeped in retirement planning, you know that 4% is often tossed around as a good starting point in terms of withdrawal rates.

This was arrived at by financial planner Bill Bengen who was trying to help his own clients as well as advisors at large figure out how much investors could reasonably take from their portfolios on a year-by-year basis. He arrived at 4% as having been a sustainable withdrawal rate for a portfolio with at least 50% in equities over a 25- to 30-year time horizon.

It's important to keep in mind the underpinnings of that 4% guideline. For example, if you're an investor who has a much longer time horizon than 25 to 30 years, maybe you're a young retiree, you would absolutely want to crunch that withdrawal rate down a little bit; 4% would probably be too much. And by the same token, if you're an investor who would like to maintain a more conservative asset allocation, you also need to be more conservative in terms of your withdrawal rate.

It's also helpful to revisit your withdrawal rate as the years go by. Check up on that withdrawal rate, especially if the market is going down. One of the best things you can do in terms of your portfolio's overall sustainability is to be willing to pull in your spending a little bit in those rough market environments to leave more of your portfolio in place to recover when the market eventually recovers. This is another reason I like the idea of this Bucket strategy for retirement portfolio planning. The basic idea there is that you are setting enough aside in liquid assets to tide you through some weak environments for stocks or bonds. The idea is that you're never having to invade your long-term assets when they're in a trough. I think it's a helpful strategy to think about and it's a way to potentially mitigate what retirement planners call sequence of return risk which simply means the risk that you will encounter a lousy market environment, especially early on in your retirement. that's the wellness check piece of the portfolio checkup.

The next stop is to take a look at your portfolio's stock, bond, and cash mix relative to your targets. Instant X-ray or the X-ray visual within Portfolio Manager can help you draw a bead on your portfolio's asset allocation and it drills into your holdings. If you have, say, mutual fund holdings that own perhaps stocks and cash within a single portfolio, X-ray actually drills into those holdings to let you see what you actually own. if you're looking at an X-ray of your own portfolio, you want to focus on the upper left square of that screen. It's kind of a data dump, so don't get distracted just yet. Focus on that upper left pie chart that you will see, and you'll be able to see your portfolio's own asset allocation. Focus on that far right-hand column of your net asset class exposures and you want to compare it where you are today with your targets to make sure that you're in good shape relative to your targets and to assess whether you need to make any adjustments.

if you have decided that you need to make changes, you can use a couple of benchmarks for evaluating your portfolio's asset allocation. Morningstar's Lifetime Allocation Indexes, I've often written about how those are a good starting point for evaluating your own asset allocation. You might also use a good target-date fund to evaluate your asset allocation. If you are someone who is getting close to retirement, it's valuable to think about your own proximity to spending your portfolio and that can help dictate how you organize your portfolio. That gets back to the Bucket approach for retirement portfolio planning.

As you're thinking about your portfolio's asset allocation, you can use either the Lifetime Allocation Indexes or a target-date fund as a starting point, but you'll also want to customize your asset allocation based on whatever you have going on. You want to think about your human capital. if you're someone who is still working, and you have a somewhat lumpy cash flow, perhaps you are maybe a commission-based sales person, or you are someone who works on a contract basis and you find that your paychecks are rather lumpy, that argues for having a more conservative asset allocation. Take human capital into account, think as holistically as you possibly can about your asset allocation. If your plan is to, for example, sell your house when retirement draws close and swap into a cheaper residence, you might think about that possibility of liquidating the home. Think as holistically as possible.

If you are looking at your portfolio's asset class exposures and you see slight divergences relative to your target, so for example, if your equity allocation target is 60% and you are at 62% today, that's probably not a reason to get in there and make a lot of adjustments. But if you do see significant divergences relative to your target, I do think that's an indication that rebalancing could be in order. You do want to focus your rebalancing activity, as I said, on your tax-deferred accounts rather than your taxable accounts where you're likely to incur some sort of tax costs to make changes.

One statistic I keep repeating because I think it bears repeating given that many investors are feeling a little bit complacent about the equity market in my view, is that if you had a 60-40 portfolio, so 60% S&P 500, 40% bond portfolio at the start of the current stock market rally back in 2009, you would be over 80% equities today, and this is without having added anything to your equity holdings. If you've just been using a buy and hold approach, you would be drifting upward of 80% equities today.

Many investors need to do some rebalancing. It's not a comfortable thing to do given that it requires you adding to an asset class that seems relatively unloved right now, bonds, and taking money away from equities which have performed well. But nonetheless, I think it's a great way to take risk out of your portfolio, especially if you are someone who is getting close to retirement. If you're within five to 10 years of retirement, I think rebalancing is especially valuable.

In addition to checking on your portfolio, your long-term portfolio's baseline asset class exposures, you want to think a little bit about your own personal liquid reserves. This is going to be money that you might hold in multiple silos not just in your investment portfolio, but in your savings account, in your checking account. You may have some sort of online savings account. You want to take stock of those liquid reserves that you could readily access in a pinch. And this slide includes some rough benchmarks for gauging whether you have enough liquidity in your portfolio.

I would really again break this into two key life stages. If you're still in accumulation mode, a good rule of thumb is that you want to hold three to six months' worth of living expenses in true cash instruments to cover you in case of unanticipated job loss, for example, or if you have some sort of emergency expenses, whether big car repairs or vet bills or medical bills or whatever it might be, I think three to six months is a good benchmark. But again, if you're someone who has a lumpier income stream from your job, you'd want to be even more conservative. Contractors, people in the gig economy, they arguably should have closer to a year's worth of living expenses set aside in case of emergency income disruption.

If you're retired, I like the idea of using six months' to two years' worth of portfolio withdrawals as a good guideline for how much to hold in cash investments. This gets back to the Bucket strategy, the idea is that you're holding enough in cash so that you're not having to disrupt your long-term portfolio, you're not having to sell bonds or sell stocks in a period of direst that you have enough liquidity set aside to meet your living expenses.

That's a rough benchmark. Certainly, if you are a more conservative investor, you might want to set the bar even higher. You just want to bear in mind that there's an opportunity cost to having too much cash. Even though we've seen higher cash yields begin to come online, it's still likely that over a five-year time horizon, or certainly longer that your money will earn more in other asset classes like bonds, certainly like stocks if you have a 10-year time horizon.

Below on the screen, we've just got a few additional thoughts for customizing the amount that you might set aside in liquid reserves. As I said, you want to be careful not to focus on X-ray for this piece of the exercise because it's going to show you residual cash that is available in some of your mutual fund holdings. This isn't readily accessible to you if you need the money. You can't call up your fund manager of your equity fund and say, oh, I just want you to give me my cash out of this holding. You would need to sell some stocks as well. Be careful when determining how much you actually have in cash.

In terms of going beyond asset allocation, I think it makes sense to troubleshoot your portfolio level risk factor. You want to focus on a couple of key things here: You want to focus on your portfolio sector and style positioning. Here again X-ray can be a great guide for evaluating your current asset class exposures and your sector and style exposure. You can see your portfolio's sector exposures arrayed within X-ray, alongside those of the S&P 500. You also want to check up on your portfolio's geographic exposure.

Finally, the stock intersection tool in Morningstar's X-ray tool gives you an eye toward how much individual stock exposure you might have in your portfolio. maybe you are someone who owns mutual funds, as well as some individuals stock positions, you may find that you've inadvertently loaded up on a handful of stocks.

In terms of portfolio-level risk factors, as I mentioned at the outset, we've seen growth stocks trounce value for quite a long period here to the point where over the past five years, the Morningstar U.S. Growth Index has returned about 5 percentage points more than the value index on an annualized basis.

if you look at your portfolio's X-ray and you haven't made any changes, you may find that your portfolio is listing toward the growth style of the style box. That's been good recently, certainly as we've seen growth stocks outperform, but we may see things swing back in the value direction at some point. if you've determined that you need to make some changes in terms of your asset class exposures, one logical place to start with that would be to think about trimming some of your growth-oriented equity positions.

Also keep an eye on your portfolio's ratio between developed and developing markets. We have seen developing markets stumble this year so far in 2018, but it's also part of a broader pattern where we've seen developed markets outperform developing markets. Over the past five years the MSCI EAFE Index, which is a developed market index, has returned nearly twice what the MSCI Emerging Markets Index has returned over the same period. That's another area where, especially if you are an investor who has a long time horizon and you have nerves of steel and you have a dedicated emerging-markets allocation, that might be another area to consider toping up, because developing markets have slumped for so long.

You also want to compare your portfolio style box exposure to the total U.S. stock market. Today, the U.S. market has roughly 75% of its assets in large-cap U.S. stocks. Roughly, another 20% or so in mid-cap stocks and then about 9% in small-cap stocks, which is not to say that your portfolio's style box exposure needs to mirror the total U.S. market exposure directly. But nonetheless, you want to just make sure that you're not making any big bets that you're not aware of. For example, if you see 30% of your portfolio or more clustered in the large-cap growth square of the style box, that might indicate that that's a spot where if you're doing rebalancing, you might want to do your trimming there.

Some additional portfolio benchmarks if you want to gauge risk factors in your portfolio. Global market cap distribution, the U.S. is currently about 53% of the total world's market capitalization. Emerging markets or developing markets are about 10% of the total world's market capitalization. Again, not to say that you need to be in lock step with these geographic exposures, but nonetheless something to think about. And I think that thinking about the ratio of U.S. to foreign stocks is particularly important for young accumulators who want to maintain globally diversified portfolios. Many of us naturally have home market bias in our portfolios. We may find that we are very much geared toward the U.S. market at the expense of foreign stocks. That may or may not be what we want in our portfolios.

Additional risk factors, things that I think of are more temporal risk factors that should be top of mind for investors right now. Tricky times for bond investors. I'm going to touch on that in a second. As I mentioned before, I do think that there is some complacency about equity risk in the market. And finally, inflation risk. This is a risk that many investors, in my view, are understating, in part because we've seen inflation be really quite benign over the past decade. But I think there's reason to be cognizant of the risk that inflation can pose for portfolios, especially for retirees who have conservative portfolios with ample exposure to fixed income securities.

Let's talk about risk factor number one. I alluded to the fact that we have seen some tough sledding for bond investors so far in 2018. The Fed has begun hiking interest rates and has hinted that there will be further rate increases later on in 2018. That puts pressure on current bond prices, because investors naturally say, why do I want this old bond with a lower yield attached to it when there are new bonds coming online with higher yields attached to them. That's why we've seen bond prices drop a bit in the first half of 2018.

I mentioned that some of the hardest hit bond types are long-duration bonds which have more interest rate sensitivity. long-term bond funds have lost about 4% for the year-to-date. Long-term government bond funds, somewhat counterintuitively given that we often think of this as the most interest rate sensitive portion of the bond market have held their ground a little bit better. Emerging-markets bond funds, as I mentioned at the outset, have been pretty hard hit.

The good news is that, I think the Fed has done a good job of telegraphing the moves that it expects to make in terms of interest rates. arguably, the Fed's near-term activities are pretty well priced into the bond market. But nonetheless, I think it's worth getting in and taking a look at your current bond holdings just to see that you are not inadvertently taking additional risks in the portion of your portfolio that you think of as the safe portion of your portfolio.

I've often talked about the virtue of conducting what I call duration stress test and the basic idea is that you are looking at your bond holdings if you have bond funds in your portfolio and you are finding a couple of data points for those funds. you are finding a statistic called duration, which is a measure of interest rate sensitivity and you are also finding the SEC yield for the fund that you have in your portfolio, and these are two data points that you can find on Morningstar.com.

You are subtracting that yield from the duration and the amount that is left over is roughly the amount that you would expect to see your bond fund lose in a one-year period in which interest rates trended up by 1 percentage point. To use a simple and potentially risky example here, let's assume you held some sort of a long-term Treasury fund in your portfolio. It has a duration of 17 years. Currently, its yield is just about 3% today. Someone holding such a portfolio could expect to lose about 13% of his or her principal in that one-year period in which rates trended up by 1 percentage point. That's a big jump up in interest rates by the way, but nonetheless something that is realistic given the Fed's anticipated action this year.

Get into your holdings, do this stress test. Just understand that it will be of limited utility, if you have non-high-quality bonds in your portfolio. perhaps you have some sort of an unconstrained bond fund or a maybe a multisector bond fund or a high-yield bond fund, this exercise is going to be less useful. It will be more useful if you have core type products in your portfolio.

The good news is, when we look across core type bond funds like the intermediate-term bond funds that many of us hold in our portfolios, you'll probably find a somewhat comforting picture when you run through this exercise. you might see a duration of five years or six years today on a lot of intermediate term bond funds. You might see a yield that's getting close to 3% today, so that would be a roughly 2% or 3% loss in a one-year period in which rates trended up by 1 percentage points.

it's a good exercise to kind of get a sense of what interest-rate volatility might lurk in your portfolio. Equity risk and complacency about it, I've mentioned a couple of times, my sense in speaking to groups of investors is that some investors are feeling a little bit complacent about having equity risk in their portfolio. It's been a long time since we had a significant market shock even though we saw a little bit of volatility in the first half we saw stock regroup pretty nicely.

The good news is when we look across our price to fair value for stocks today, we don't see any reason for great concern in terms of valuation risk. But nonetheless, I think it's remembering that for most investors, if they've been hands off with their portfolios, their equity exposure has grown larger. At a minimum take a look at your asset allocation versus your targets, take a look at your growth versus value split and then also if you are doing any forecasting, if you are plugging returns into any sort of retirement calculator and you are thinking about near-term equity market returns, I'd plan to be pretty conservative if you are forecasting returns for the next decade.

My advice is to think small and be surprised on the upside if things are better than you expected. For equity market returns, I'd be inclined to use low-single-digit returns for the next decade. If you are a young accumulator and you think you have like a 20- or 30-year time horizon until retirement, you can safely use long-term equity market averages as a starting point if you are using some sort of a retirement calculator. I think, you are probably OK using say an 8% equity market return if you have that very long time horizon.

In addition to those two risk factors that we talked about where we talked about interest rate-related volatility as well as complacency about equity risk. I think there is also some complacency about the potential for inflation. And granted, I'm the first to say that I've been kind of worrying about this for the past several years and inflation really hadn't materialized in a meaningful way until quite recently. But I do think that there is more reason for concern today in part because we have continued strength in the economy, continued strength in the job market, and also we have the recent tax package, which arguably has some inflationary characteristics.

I think, it's valuable to make sure that your portfolio is adequately hedged against inflation. If you're a young accumulator, the best way to make sure that you have inflation protection in your portfolio is simply to hold ample exposure to stocks. And that's true if you're retired, too. But if you have a heavy allocation to bonds in your portfolio and you're someone who's getting close to retirement and you're going to be drawing from that portfolio, I think it makes sense to make sure that you have adequate inflation protection in your portfolio.

One quick point about retirees, and this is something I've been looking closely at, is the fact that we've recently seen healthcare inflation begin to spike up a little bit after a period of being relatively benign. This is potentially a risk factor for retirees for whom healthcare costs tend to be a larger share of their consumption basket than the general population.

I mentioned how a couple of steps for shielding your portfolio against inflation. Holding ample equity exposure is one of the best ways to do that. If you have bond positions making sure that you have inflation-protected bonds in your portfolio, you might also think about holding some niche asset classes with inflation protective abilities. On the short list might be real estate, commodities which are volatile, but over long periods of time have been shown to have some inflation fighting abilities.

Bank-loan investments are another category to keep an eye on. We showed earlier on that they performed particularly well in the year's first half. They tend to be relatively impervious to changes in interest rates, and they historically have performed pretty well in periods when inflation has been running hot.

In terms of individual holdings review, obviously, your own portfolio is going to determine where you spend your time here. But Morningstar premium users have access to a lot of great tools in terms of checking up on their holdings. Analyst Ratings are a great place to start, whether you're an individual stock investor or you're a mutual fund investor or an ETF investor. And the gold standard in terms of reviewing individual holdings is, certainly, the analyst report, which pulls together a lot of different threads, a lot of different data points to give you a sense of whether our analysts think a security is worth owning or potentially worth casting off from your portfolio. Use those great premium resources that you have available to you as a Morningstar.com premium user.

In terms of an action plan for 2018, we obviously want to use the output from the portfolio review that you've just conducted. You want to determine whether there are any problem spots that you want to address in terms of your portfolio changes. You also want to make sure that your contributions are on track. If you're someone who's still contributing assets for retirement, you want to make sure that you are trying to max out your contributions to all of the tax-sheltered vehicles you can get your hands on.

I've outlined on this slide the contribution rates for 401(k) plans or other tax-deferred company retirement accounts, Roth accounts as well adhere to those same income levels. We saw income limits and contribution limits. We saw contribution limits increase a little bit in 2018. For people under 50, it's $18,500; for people over 50, it's $24,500. IRA contributions are staying the same for 2018 as they have been in years past. They're stuck at $5,500 for people under age 50 and $6,500 for people who are over age 50.

If you're a high-income investor and you are reaching for a higher savings rate, you can think about investing within a taxable account and that will certainly give you the most flexibility in terms of your investment selections and, certainly, in terms of access to your money if you need it. But if you're in a position to save even more in tax-sheltered vehicles, a couple of account types I would draw your attention to.

One is after-tax 401(k) contributions. These are available to some 401(k) and some tax deferred retirement plan participants. And it's something to think about. Once you've maxed out your contributions to your regular IRA and your regular company retirement plans, you might want to think about making these after-tax contributions. The beauty of making after-tax contributions is that you may eventually be able to convert those assets to Roth accounts. Some 401(k) plans include what's called an in-plan conversion option that lets you convert your traditional after-tax 401(k) contributions to Roth inside the plan. This is something to check with your plan administrator or check with your HR department about if this sort of account type is of interest to you.

Another account type to consider would be a health savings account, which you can use to certainly defray ongoing healthcare expenses, so you can use it as that HSA was originally intended to help pay your out-of-pocket healthcare costs if you are covered by a high deductible healthcare plan. But if you're a high-income investor, who's in a position to pay those healthcare expenses using non-HSA assets, so you can use your taxable assets to pay those healthcare costs, you might consider using the HSA, as an auxiliary retirement savings vehicle. The beauty of the HSA in contrast with every other retirement savings vehicle is that it's triple tax advantaged. you're able to contribute pretax dollars, your money accumulates on a tax free basis. And then assuming you pull the money out for qualified healthcare expenses those withdrawals will also be tax free.

it's a really valuable asset to take with you into retirement, if you possibly can to cover those out-of-pocket healthcare costs. And people always say, well, how much should I save within my HSA. I think it's important to remember the magnitude of healthcare costs for many retirees, those out-of-pocket healthcare costs. The most recent Fidelity Investments estimate, for example, was $270,000 for a 65-year-old married couple over their retirement life cycle. That's how much they can expect to pay in out-of-pocket healthcare costs. Those are not small numbers and something that if you are a high income investor who's in a position to leave your HSA intact, that can be a really valuable strategy.

If you find yourself with additional time as 2018 winds down, just a couple of evergreen to-do's that I would say to put on your radar. One is to think about creating an investment policy statement. This is essentially a blueprint that helps you delineate--here's what I'm trying to achieve, here's my target savings goal, here's how much I'm hoping to accumulate whether for retirement or some other goal. You are enumerating your investment goals. You're also talking about the criteria you'll use for selecting investments. You'll talk about how often you'll monitor your investments on an ongoing basis. You'll talk about your asset allocation and how you expect it to change, as the years go by.

I think the best investment policy statements aren't complicated and overwrought, but instead really cut to the chase about what you're trying to achieve with your plan. And the value of an IPS in addition to it being something that can keep you on track, is that it can serve as a check against your own worst instincts. If you've laid out in your IPS that you want to stick with a 65% equity, 35% bond weighting and then the equity market gets spooky. Having the IPS may serve as a disincentive to upend that plan when things get tough. I also like the idea of creating a retirement policy statement. If you're someone who's already retired or getting close to retirement, we've created templates for both retirement policy statements, as well as, investment policy statements on Morningstar.com.

In the RPS, in contrast with the investment policy statement, you're laying out your decumulation strategy. You're talking about your withdrawal rate. You're talking about how you will potentially tweak that withdrawal rate as the years go by. You're talking about the specific strategy that you'll use to extract cash from your portfolio on an ongoing basis throughout retirement. Will you be someone who relies exclusively on income distributions, will you use a pure total return approach and look strictly to rebalancing to fund your cash flow needs. Your RPS lets you lay all that out and again, we have a template for an RPS on Morningstar.com.

I also like the idea of using your midyear checkup, as an opportunity to review your beneficiary designations. Things can change. You may have changed investment providers and your beneficiary designations may not have ported over to your new accounts. Or things may have changed in your own life. Maybe you got married or had a child or got divorced or other major life changes. You want to make sure that your beneficiary designations address those changes as well.

I'm a big believer in having a master directory, something that delineates where you hold your investments. Any sort of documentation, like passwords that you use to access those accounts, any individuals that you deal with at various financial firms, you've got that all laid out in this master directory. Here again, we've got a template for a master directory on Morningstar.com. The key thing you need to think about and you probably were already thinking about this is that this master directory has a lot of sensitive information in it. If you've got a master directory, whether it's a printed copy of something or some sort of electronic document, you need to take steps to make sure it's secure. if it's a physical document, make sure that you've got it under lock and key, either in your safe deposit box or some sort of a locked file drawer at home. Or if you've got an electronic document, make sure that it's an encrypted document that someone could not readily access.

Finally, I like the idea of creating and using a password manager, if you possibly can, to maintain your passwords and to maintain the security of your online accounts. Many of us are doing more and more of our financial track transactions online, which in many respects is a safer way to go about doing it than receiving paper statements and doing other sorts of transactions. But the password manager can help you stay safe online. It's a little bit of an investment at the outset to get a password manager up and running for your own accounts, but the good news about such a manager is that it does keep your portfolios updated and make sure that they're complicated passwords that no one could readily tap into.

I'm going to leave it there. Those are my prepared remarks. But I know some questions have been rolling in and I'm happy to tackle some of them. My colleague Jeremy Glaser has snuck in here and joined me and is going to share some of the questions that we've been receiving.

Jeremy, thanks for coming.

Jeremy Glaser: Christine, thank you. It was a great presentation and like you mentioned, a ton of questions came in. let's get to them. The first is about the potential of a recession. No one knows exactly when. There probably will be another recession some time, and what that means for your Bucket strategy, portfolios for retirement, portfolios generally, if you think a recession is imminent, is there anything you should be doing now to potentially prepare?

Benz: Yeah, it's a good question. One thing that I know a lot of people have been keeping an eye on is the fact that we have seen the yield curve flatten, which historically has been a precursor to some sort of a recessionary environment. It's actually the inversion of the yield curve that typically makes people spooked about a recession being imminent. But nonetheless, that has stoked some concerns that the economy could slow down eventually.

In terms of how that would intersect with the Bucket strategy, that's something I think a lot about. I do think that having bonds within the portfolio, having a decent-size cash component of a retirement portfolio is one of the best ways to safeguard yourself against a recessionary environment. I know some investors may be looking at these Bucket portfolios, and I've gotten feedback from readers who have said those things are quite fixed-income heavy, but the reason is that the portfolios have ballast in case the equity portion of the portfolio sees some sort of a drop off, which I think is probably inevitable sooner rather than later. I think it makes sense to maintain ample cash and bond exposure.

Glaser: We did get quite a few questions about bonds and the right kind of bond exposure. I know you touched on that a little bit in the presentation. But we have specific question about using CDs as a substitute for short-term bonds. When would that make sense, when would that not make sense? How would you think about that decision?

Benz: I know investors have been grappling with this, especially as we've been seeing higher yields come online within cash instruments. The idea of laddering CDs I think can be a sensible one, especially if you're expecting higher yields to come online down the line, so you're not locking yourself into a single CD with its current yield, that you're exposing yourself to a variety of interest-rate environments. I think that that can be a useful strategy. For investors who need daily liquidity, they might consider some sort of an online savings account as an option where we're seeing yields getting pretty close to 2% and in some cases, edging over 2% in online savings accounts, which also offer, like CDs, FDIC insurance. In contrast with CDs, they offer daily liquidity or maybe liquidity with a few structures.

Certainly, investors should think about making sure that they have adequate liquidity in their portfolios. I wouldn't take my whole bond allocation and supplant it with cash holdings, especially if I have a sizable bond position. The reason is that I think if you do have a five-year time horizon, your bonds will probably outperform the risk-free cash piece. Just be mindful of the opportunity cost by staking your whole portfolio in cash instruments.

Glaser: Continuing on that bond theme, on munis, if you were thinking of buying a muni fund, how would that react to a rising interest-rate environment versus a regular, intermediate core bond fund? What would be some of the distinctions there?

Benz: It's a good question. The interesting thing was in the first half of 2018 that we did see munis hold up a little better than taxable bonds during this period. I'm not a bond market expert, so I can't say specifically why that was. But here again, I think that that little bit of duration stress tests can make sense. It's important to bear in mind that a lot of muni issuances I referenced at the outset of the presentation is long term, a lot of the funds are pretty long-term oriented. Think about matching the maturity of that portfolio with your own time horizon. If you have a short time horizon, you're better off sticking--and by short, I mean fewer than five years--you're better off sticking with some short or limited duration muni fund. If you have a longer time horizon, you're probably just fine in an intermediate-term muni fund.

It's also worth thinking about the single state question versus the diversified muni fund question. If you live in a high tax state, whether California or New York or New Jersey, you may want to think about owning that single state fund which gives you the state tax break in addition to the federal tax break that all of us earn on muni funds.

Glaser: This is a bit of a combined question, but the first part was about Jack Bogle and how you should think about Social Security--if it's a bond, if it's not a bond in terms of your asset allocation. What's your take on that? Do you think that Social Security should be kind of a part of that fixed-income part of your portfolio?

Benz: I'm never one to argue with Jack Bogle. This is one area that where I think a little bit of nuance is in order. I would get back to that slide in the presentation where we looked at how much of the income needs were being met through those certain sources of income. Say, my income needs per year in total are $60,000 and I'm getting $30,000 of that from Social Security, then that means that my portfolio withdrawal is $30,000. I would then stage the portfolio accordingly. I would definitely factor in the role of Social Security. But if I'm using, say, the Bucket strategy and my portfolio withdrawal is $30,000 a year, that would call for having a couple of years' worth of those portfolio withdrawals in cash and then stepping out on the risk spectrum with the rest of the portfolio. In my Bucket portfolios, I've used to like eight years' worth of portfolio withdrawals in high-quality bonds. Going back to that $30,000 annual portfolio withdrawal, that would be roughly $240,000, $250,000. Then the remainder of my portfolio could go into stocks. From a practical standpoint, I think that that strategy does factor in the impact that Social Security has in terms of meeting retirees' real income needs, but I think I would rather see investors back into asset allocation in the way that I just outlined.

Glaser: That I think answers the second part of the question, which is about if you have a pension, how you would factor that into your buckets? Will it be a similar story?

Benz: Exactly. That would come out at the front end. I often talk to pensioners--and there are still some out there--who have most of their income needs being met through pension and/or Social Security, and in that case, especially if it's in the case of a couple, in that case from a practical standpoint calls for having quite an aggressively positioned portfolio, assuming that the retirees are comfortable with the volatility that will inevitably accompany a very equity-heavy portfolio.

Glasser: We had two questions from investors who are hoping to leave a sizable legacy to charitable organizations. They are wondering how that should impact the way that they are thinking about their asset allocation, anything they should do now? One person mentioned their financial advisor wants them to pull back on risk. But if you're really thinking about a legacy and not necessarily cash flow, how does that impact your investment decisions?

Benz: It's a good chance, if they are working with a financial advisor that that person has a sense of cash flow and what's appropriate given their expected withdrawals from the portfolio. I certainly wouldn't undermine anything that the advisor, who's familiar with their plan, might say. But generally speaking, if people look at their portfolio withdrawals and see, gosh, my portfolio is much larger than I'll ever need during my lifetime and most of this is for my kids, grandkids, charity, what have you. In that case, in very general terms, not speaking to these particular individuals, that calls for having a more aggressive equity position. There are a couple of additional strategies to keep in mind, especially for charitably inclined retirees.

One I would call out is the idea of using a qualified charitable distribution. if you are post age 70 1/2 and you're subject to required minimum distributions, thinking about taking a percentage of those required minimum distributions up to $100,000 and steering that to the charity of your choice, that way those withdrawals do not affect your adjusted gross income and can keep that number down and reduce the amount of taxes that you'll pay. That's a strategy to keep in mind for retirees who are charitably inclined as opposed to those who want to leave the money for kids, grandkids, other family members.

Glaser: Next question is a little bit more product focused. It's about the Vanguard Target Retirement Income Fund. It's a fund that targets an income payout, almost like a target-date fund in retirement, I think would it be a fair way to describe it. I know there's others in different fund families. If you wanted to use a product like that, how does that fit in with the rest of your portfolio? Where would that that fit in, say, a Bucket strategy or another piece of asset allocation?

Benz: Generally speaking, those all-in-one finds, the target funds whether for accumulators or decumulators are designed to be kind of one and done. You want to bear in mind if you have other assets over here, you want to use X-ray, see how those different investments intersect with one another. For example, if you had $200,000 in a target retirement income fund, but you also had $800,000 in equity, just bear in mind that your equity portfolio is going to be the big determinant of how your portfolio behaves obviously. Look at the whole portfolio's asset class exposures, but those all-in-one funds are generally designed to be one-stop shops. I think they can be pretty effective though for investors who, for whatever reason, have small accounts. Maybe you have a small IRA, for example, but most of your assets are within your company retirement plan where you actively manage those assets. I think that those all-in-one funds can be particularly effective one-stop-holdings in such situations.

Glaser: Christine, that's all the time we have this afternoon. But thank you so much for tackling these questions and for sharing your five easy tips on doing that midyear checkup.

Benz: Thank you, Jeremy.

Glaser: Thank you so much for joining us this afternoon.