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Summer Sun Shines on Midyear Portfolio Reviews

Christine Benz details what to look for in your midyear portfolio checkup.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Susan Dziubinski: Hi, I'm Susan Dziubinski with morningstar.com. It may seem difficult to believe, but we're almost at the halfway point of 2020, and this is the time of year when investors take a look at their portfolios and do a mid-year portfolio check-in. Given how volatile the market has been this year, we're going to have a talk today with Christine Benz, our director of Personal Finance, to get her take on what we should be looking at as we do our check-ins this year. Christine, thank you for joining us today.

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

Dziubinski: Now, it certainly has been a bumpy ride this year. What should we have on our radars as we're starting to take a look at our portfolios?

Benz: Well, I always liked the idea of putting kind of a wellness check at the top of the list if you're looking at a portfolio checkup. Start with the health of your plan. So if you're someone who's in accumulation mode, the key metric there is that you're looking at your savings rate. Obviously, we're in an environment where a lot of people have seen income disruptions. So maintaining a savings rate in line with what you had hoped to do at the outset of this year may not be attainable, but if you are still employed and still on track with your savings, look at whether you are on track to max out your tax-advantaged vehicles, if you can. Just check up on how you're doing in terms of your retirement trajectory.

If you're someone who's already retired, the key metric of your plan's health is your withdrawal rate. And we have seen a great snap back in the equity market. So a lot of portfolios have made a great comeback as well. That means that perhaps the warning lights aren't necessarily flashing in terms of reducing withdrawals, but I think retirees want to be mindful of that idea, especially if they're just embarking on retirement. And the key reason is that we've seen yields drop really low on bonds and certainly on cash. And that means that the raw materials for balanced portfolio returns may not be that great over the next decade.

So check your withdrawal rate. We did an interview with Wade Pfau, who is one of the gurus in retirement research and on retirement withdrawal rates, specifically. And he argued that 3% as a starting withdrawal rate is safe for new retirees. Take a look at where you are coming out in terms of your spending so far, six months into the year.

Dziubinski: And the next step you recommend is that people take a look at their asset allocation specifically at their allocation, just sort of those safer, more conservative investments. What should we be thinking about here?

Benz: Absolutely. It's a great time to check up on your portfolio's cash reserves, your liquid assets that you could draw upon in a pinch. We've certainly seen in stark relief through this crisis where people have had income disruptions, income losses, they've lost their jobs. So for people who are still in their accumulation years, it really is well worth checking to see how you're doing with respect to your emergency fund.

The standard rule of thumb has been three to six months worth of living expenses that you have parked in highly liquid assets. I would say for some workers, maybe contract workers, people working in the gig economy, we see through this crisis how that should probably be a larger number for a lot of households. So check up on your cash reserves.

If you're someone who's retired, you need cash too. I would argue that retirees should think about having a couple of years worth of portfolio withdrawals parked in safe assets. The idea is that if it's not a great time to withdraw from stocks, it's maybe not a great time to withdraw from bonds. You'll have your cash reserves that you can draw upon instead. So take a look at those cash reserves, make sure that you have those liquid assets.

Dziubinski: Pivoting a little bit now to those longer-term assets, what should we have on our radars there? And are there any particular benchmarks or guideposts that we should be looking at?

Benz: Here I think our x-ray functionality that we have on Morningstar's portfolio manager tool is really invaluable in terms of getting your arms around your total portfolio's asset allocation. So take a look at that. If you have not made any changes recently, or even for a few years, you may find that your portfolio is actually too aggressive given your life stage, especially if you're someone who is within maybe a decade of retirement, or certainly someone who is within a few years of retirement. You do need to de-risk the portion of your portfolio that you expect to spend from soon.

So take a look at that asset allocation using x-ray. You might use a target-date fund, especially if you're a younger accumulator, to try to make sure that your asset allocation is in the right ballpark. For younger investors, they probably will find that target-date funds are recommending 80%, 90% in equities. And certainly if they can withstand the volatility that comes along with a higher equity allocation, they should be up in that very high range of equity exposure, mainly because bond yields are really low today and that foretells pretty poor returns from bonds over the next decade.

Dziubinski: So in addition to sort of that stocks/bonds mix, that overarching asset allocation that we'd look at, what are some of the other things we should go a little bit more deeply into the portfolio and look at?

Benz: Well here again, I think x-ray can help you get your arms around your portfolio's investment style exposure. We're in this period where we've seen absolutely tremendous performance from large-growth stocks, technology stocks in particular. Those big-name tech stocks have really been pacing the market. If we haven't been paying close attention, our portfolios may be drifting up in terms of their exposure to that top right-hand square of the style box. So take a look at that. Take a look at whether your portfolio isn't disproportionately skewing toward large growth stocks.

Also look at your portfolio's geographic exposure, because we've generally seen U.S. stocks outpace foreign stocks year to date. Younger investors especially, but really investors at all life stages should have ample allocations to non-U.S. stocks as well as U.S. stocks.

And finally take a look at individual stock exposure. Certainly if you have employer stock, it can become easy to be overweighted in your employer's stock. And if you're lucky enough to still have a job, you probably don't want too much of your financial wherewithal riding on your employer's fortune. So drill into the asset allocation, drill underneath asset allocation, to look at some of these other factors as well.

Dziubinski: We talk at Morningstar a lot about costs, and how cost over time can really erode your returns. So how can we incorporate a cost audit into our midyear checkups?

Benz: Right. Our colleague, Ben Johnson, just put out a great report looking at the trends in fund fees. And what we see is that fund fees are coming down and investors are choosing cheaper funds. So if you haven't taken a closer look at your portfolio with respect to how much you're paying in mutual fund fees, take a look at that. It may be that you can obtain the same exposure at a lower cost by swapping into a broad market index fund, or an ETF, or a cheaper active fund, if you prefer to go to the active route.

Look at the whole gamut of costs though. Don't just start and end with fund fees. Look at how much you're paying financial advisors, how much you're paying in brokerage commissions. Also take a look at implicit costs that you might be paying. So we talked about how low yields are today on cash. Well, they're especially low in certain types of accounts--brokerage sweep accounts, I would point out, have notoriously high costs and low yields. So if you have cash holdings in your account, make sure that you're not seeding too big a share of your yield to expenses.

Dziubinski: And lastly, Christine, you've talked before about the importance of tax efficiency, and how can we perhaps be thinking about taxes or doing a tax audit as part of a midyear portfolio checkup?

Benz: Right. Do a quick review of this, and mainly that starts with looking at whether you are taking maximum advantage of those tax-sheltered accounts that you have available. So IRAs, you actually have until July 15th to make an IRA contribution for 2019. So take a look at that. Take a look at how you're funding your company retirement plan. Also take a look at whether if you have non-retirement, non-tax-sheltered accounts, whether you are investing those as tax-efficiently as possible. So do you have index funds there? If you have bonds in your taxable account and you're in a high tax bracket, do municipal bonds make more sense for you?

And finally, one thing we've been hearing a lot about from planners we talk to is the idea of looking at Roth conversions in 2020. I would say retired investors who don't have to take their required minimum distributions this year are particularly good candidates for taking a look at whether conversions might be in order, might make sense for them. That particularly makes sense for people who have IRA assets that they don't expect to spend during their lifetimes, where they're saving in those accounts, mainly for their heirs. In that situation, get some tax advice and see whether converting part of those assets might make sense for you.

Dziubinski: Christine, thank you so much for the concrete steps that we can take to make sure our portfolios are on track mid year. We appreciate your time.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with morningstar.com. Thank you for tuning in.