How to Make Over Your Own Portfolio

Editor’s note: This video is part of Portfolio Makeover Week 2019. Coming Monday, Christine Benz helps investors check their progress, assess allocations, target holes and overlap, and upgrade their holdings.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. It's portfolio makeover week on Morningstar.com. We're featuring five real-life portfolios of our readers, which are then made over by Christine Benz, our director of personal finance. Christine is here today to talk with us about how to perform your own portfolio makeover.

Christine, thank you for joining us today.

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

Dziubinski: So, the first step is doing the legwork is to get all the information together, right?

Benz: That's right. So, gather up all of your statements for all of your accounts, whether long-term investment accounts, shorter-term savings vehicles that you might have, whether checking accounts, online savings accounts. Get all those balances, get the amount that you have in each of your holdings. That's really the starting point for the process. And that's the first step that we go through when we work on portfolio makeovers with our users.

Dziubinski: So, then you want to look at how you're doing relative to your goal. How exactly do you do that?

Benz: Well, really, I think the important point is that some financial planning should precede the portfolio planning. So, it really depends on where you are in your life stage and what your goals are. For younger investors, we talk about savings rate, looking at whether their savings rate falls within that sort of good zone that we look for, of roughly 15% of their income. We also look at some of their capital-allocation choices. So, many people, younger folks especially, have heavy student loan debt, and we look at sort of optimizing allocations across paying down debt as well as investing in long-term or maybe even short- and intermediate-term assets. For older investors where retirement is close at hand or maybe has already begun, one of the key things we think about is the viability of the plan given the spending rate from the plan. Looking at the positioning of the investment portfolio really comes after looking at some of those key metrics that relate more to financial planning.

Dziubinski: And then, once we do get to the investment portfolio, the first step of that process is looking at your overall asset allocation, right?

Benz: That's right. And here I think Morningstar's X-ray functionality can be really valuable in terms of assessing your portfolio's baseline asset class exposure. So, you're able to see your equity versus bond allocations, you're able to see how much of your equity portfolio is in U.S. stocks versus foreign. So, I think that that's a good next step. So, you're essentially assessing your positioning in terms of your asset class exposures relative to whatever goals you have to achieve. Another thing I always take into account though is shorter-term assets that someone might have on hand. So, we all need emergency funds throughout our lives to cover those unexpected expenses. In retirement, I'm a big advocate of people having a couple of years' worth of planned portfolio withdrawals in cash reserves. So, I look at the liquid assets as well as the long-term asset class exposures.

Dziubinski: And when you're looking at asset class exposures, if you've looked at your stocks, bonds, and cash mix, how far down do you go into sort of those sub-portfolio allocations? What should you be looking for there?

Benz: Well, quite a bit. And here again, I think X-ray can be valuable in terms of helping you see your sector exposures relative to the S&P 500, helping you look at your portfolio Style Box exposure. So, someone could have equity exposure that's right on target with where they should be given their proximity to spending from their portfolio, but the complexion of that asset class exposure could be really weird. It could be that they have all of their exposure in just a handful of sectors. So, we try to address those sorts of issues with the makeovers because you--even though you might have the asset class exposures right, you could be courting risk with some of the Style Box or sector exposures.

Dziubinski: And speaking of courting risks, I would think now would be a good time during a makeover to be considering too how much exposure we have to any particular security.

Benz: Absolutely. And that's another feature in the X-ray functionality. You can see how much you have in direct exposure to individual stocks, as well as indirect exposure that you're getting through mutual funds that you might own. So, maybe someone has a 5% position in Apple stock straight up. Well, guess what, if you have an S&P 500 index fund, you're also getting plenty of exposure through that holding. So, take a look at that. Another place where this can come into play is for people with employer stock, that this can be a nice perk at many employers, it can be a real source of wealth in many households, but it also adds risk to a portfolio in the people with jobs who are getting compensation through company stock have a lot riding on their company as it is. So, that's something that we try to address and think about how to perhaps reduce that exposure and do it in a tax-sensitive way.

Dziubinski: If I'm looking at my portfolio, and I'm doing a makeover, and I look at this, and I say, gosh, there's a lot going on here. How could one go about streamlining their portfolio during the makeover process?

Benz: That's a really common goal and focus of the makeovers that I do, where we just try to simplify all of the moving parts in the portfolio. So, I really think it starts at the account level, where many folks have multiple tax-deferred accounts. So, they're managing separate silos, but many times those assets can be moved together and amassed so that you can just have a single tax-deferred account versus three or four. So, that's one key thing to look at. And then, within those portfolios, so assuming that you've skinnied-down the number of actual accounts, you can actually look at, well, Is there a way to get my U.S. equity exposure done with just a couple of holdings or even one holding versus the six that I was carrying around? So, we try to simplify at the inside portfolio level as well as the account level.

Dziubinski: What about taxes during the portfolio makeover process?

Benz: Well, this is really top of mind, especially because we've had such a great market for so long, many investors have highly appreciated assets within their taxable accounts. So, you need to be very careful if you're doing repositioning to make sure that you are not triggering any tax bills that you're not going to be able to pay, or that won't create some sort of other hardship for you. So, it's important to undertake a portfolio makeover with a full recognition of the fact that you want to try to move the needle with tax-deferred or Roth holdings first and foremost, because you won't face any tax consequences to do repositioning there. If you're looking at taxable accounts or oftentimes employer stock, you want to really take all the tax effects into account before making any changes.

Dziubinski: So, lastly, Christine, what other sort of risk factors should we take into consideration if we're doing a portfolio makeover?

Benz: Well, I think you really want to think hard about your own particular situation. I've had more than a few portfolio makeovers over the years where someone had a loved one, an adult child or a younger child, with special needs, for example. So, it's important to think through some of the considerations that might be involved there, some special estate planning that you'd want to do to help ensure that you are setting aside assets for that loved one, and doing so in a way that won't jeopardize their eligibility for other types of aid that they might be able to take advantage of. So, you want to take stock of personal factors such as that.

You also want to think through your insurance coverage. I think if you're doing that total wellness check, you want to think about long-term care insurance. That's definitely top of mind when I work with older adults who are getting close to retirement. If they have not set aside assets for long-term care, we sort of think through, well, what are the options at this point?

Another thing I've been thinking a lot about, inspired by our colleague David Blanchett's work on what he calls “retirement date uncertainty” is, even if the person's plan is for them to work to age 68 or 70, or something like that, and that's the goal for a lot of folks these days, I think we need to think through What is our plan if this can't happen? Or what is our plan for insurance if for whatever reason you can't work until age 65? Because we know that that's a big worry for a lot of folks, health insurance pre-Medicare. So, we try to think through, well, what are the risks. Even in a best-case scenario, if this thing works out exactly as you hope it will, what are the risks in case it doesn't, and I think it's important to think that through for yourself as well.

Dziubinski: Great. Well, thank you for your time today, Christine. We'll all go home and plot our information and do our own portfolio makeovers.

Benz: Thank you, Susan.

Dziubinski: For Morningstar, I'm Susan Dziubinski. Thank you for tuning in.