How to Conduct Your Own Portfolio Makeover

Over the years, I’ve conducted dozens of portfolio makeovers for Morningstar readers, digging into the situations of real-life investors and sharing my ideas about how they might improve their portfolios and financial plans. But not everyone gets the chance to receive a makeover. The good news is that with a bit of time and discipline, investors can undertake their own portfolio makeovers along the same lines.

If you'd like to conduct a thorough review of your portfolio and plan, here are the key steps to take. And remember, you don't have to get through all of them in one sitting. For your own sanity, it's going to be much more manageable and effective to knock off these jobs over a series of sessions rather than all at once.

1. Gather up your documentation.
2. Ask and answer: How am I doing?
3. Check up on your long-term asset allocation.
4. Assess liquid reserves.
5. Assess suballocations, sector positioning, and holdings.
6. Identify opportunities to streamline.
7. Manage for tax efficiency.
8. Troubleshoot other risk factors.

Step 1: Gather up your documentation.

The first step in the makeover process is to gather up current documentation related to your investments—either your paper statements, to the extent you still receive them, or the latest online statements you have.

In addition to your latest investment statements, gather up documentation on other important, nonportfolio aspects of your financial plan: Social Security statements and pension documents, for example. Everyone should have set up a My Social Security account, which gives you an overview of your benefits and earnings history. If you're closing in on retirement, planning the amount and timing of your benefits will be crucial.

Step 2: Ask and answer: How am I doing?

The next step in the process is to conduct a wellness check. Ask yourself: Am I on track to reach my financial goals?

If you’re still accumulating assets for retirement, check up on whether your current portfolio balance, combined with your savings rate, puts you on track to reach whatever goal you’re working toward. Tally your various contributions across all accounts so far in 2023: A decent baseline savings rate is 15%, but higher-income folks will want to aim for 20% or even higher. Not only will high earners need to supply more of their retirement cash flows with their own salaries (Social Security will replace less of their working incomes), but they should also have more room in their budgets to target a higher savings rate. In addition to assessing your savings rate, take a look at your portfolio balance: Fidelity Investments has developed helpful benchmarks to gauge nest-egg adequacy at various life stages. (My colleague Amy Arnott took a look at these benchmarks; she concluded that they’re reasonable overall but won’t work for everyone.)

Also factor in other goals you'd like to achieve before retirement, such as college funding or a home down payment. Are they realistic? Are you potentially overprioritizing them and giving short shrift to retirement?

If you’re retired or getting ready to, the key gauge of the viability of your total plan is your withdrawal rate—your planned portfolio withdrawals divided by your total portfolio balance. The 4% guideline is often held out as a good starting point, having been stress-tested over a variety of time periods. But ideal withdrawal rates are always under debate. If you want to be conservative, err on the side of a lower starting withdrawal. If you haven’t yet retired, will a lower withdrawal, combined with income from other sources, supply you with the income you need?

All-in-one retirement calculators can also be useful when assessing the viability of all aspects of your plan. Tools like T. Rowe Price's Retirement Income Calculator and Vanguard's Retirement Nest Egg Calculator bring all of the key variables together and help you identify areas for improvement. And of course, if you're contemplating retirement or already retired, this is an excellent area to get a second opinion from a professional. The stakes are simply too high to go it alone.

Step 3: Check up on your long-term asset allocation.

Once you’ve evaluated the health of your overall plan, turn your attention to your actual portfolio. The portfolio tool in Morningstar Investor provides a look at your total portfolio’s mix of stocks, bonds, and cash. You can then compare your actual allocations with your targets. If you don’t have targets, high-quality target-date series such as those from Vanguard and BlackRock’s LifePath Index Series can serve a similar role for benchmarking asset allocation. My model portfolios can also help with the benchmarking process.

Given that stocks generally outperform other assets over time, some investors may find that their portfolios are heavy on stocks relative to the above benchmarks. A portfolio that tilts mostly or even entirely toward stocks makes sense for younger investors with many years until retirement. At this life stage, you absolutely need the growth potential that comes along with stocks, so it’s wise to maintain as high an equity allocation as you can tolerate.

But a too-heavy equity portfolio is a far more significant risk factor if you are nearing or in drawdown mode: Insufficient cash and high-quality bond assets to serve as ballast could force withdrawals of stocks when they're in a trough, thereby permanently impairing a portfolio's sustainability. If your portfolio is notably equity-heavy relative to any reasonable measure and you're within 10 years of retirement, derisking by shifting more money to bonds and cash is more urgent. You could make the adjustment all in one go or gradually via a dollar-cost-averaging plan. Just be sure to mind the tax consequences of lightening up on stocks as you're shifting money into safer assets; focus on tax-sheltered accounts to move the needle on your total portfolio's asset allocation or steer new allocations to the safer asset classes that need topping up.

Step 4: Assess liquid reserves.

In addition to checking up on your portfolio’s long-term asset allocations, another part of any portfolio review is a check on your liquid reserves. Though you would likely be able to find higher returns in other asset classes, don’t overlook the role that cash plays in your portfolio. Holding some cash is crucial to ensure that you don’t have to tap your investments or resort to otherwise unattractive forms of financing, such as credit cards, to tide you over through a financial crunch.

For retired people, I recommend holding six months' to two years' worth of portfolio withdrawals in cash investments; those liquid reserves can provide a spending cushion even if stocks head south or bonds take a powder. Retirees whose portfolios are equity-heavy can use rebalancing to top up their liquid reserves.

For people who are still working, holding three to six months’ worth of living expenses in cash is a good starting point when rightsizing liquid reserves. Contractors, older workers, and/or people with more specialized and/or higher-paying careers should target a higher amount, closer to a year’s worth of liquid reserves.

Step 5: Assess suballocations, sector positioning, and holdings.

Your broad asset-class exposure will be the key determinant of how your portfolio behaves. But your positioning within each asset class also deserves a closer look. Despite growth’s major drawdown in 2022, growth has outpaced value by a wide margin so far in 2023 and outperformed over the past five years. Check your portfolio’s Morningstar Style Box exposure in Morningstar Investor to see if it’s tilting disproportionately to growth names.

While you’re at it, check up on your sector positioning. Additionally, check your portfolio’s allocation to foreign stocks: Not only have they underperformed U.S. stocks for the year to date but over longer time periods, too.

Finally, check up on your actual holdings. Morningstar Ratings for stocks and Morningstar Medalist Ratings for funds and exchange-traded funds provide a quick way to identify trouble spots. Be on the lookout for stocks that rate 1 or 2 stars and funds that rate Neutral or even Negative and consider upgrading those positions.

Step 6: Identify opportunities to streamline.

With my makeovers, I always look for opportunities to streamline portfolios, and you should do the same. Why have scores of accounts and holdings if a more compact portfolio could do the job just as well?

Start at the account level: Do you spot opportunities to combine like accounts? Because so many people make frequent job changes, it’s not uncommon for investors to have multiple pools of tax-deferred assets; old 401(k)s and multiple rollover IRAs, for example. Those accounts are prime options for consolidation into a single IRA. People often hold several small cash accounts, too, losing out on the opportunity to simplify and potentially earn a (slightly) higher yield by consolidating.

In addition to streamlining at the account level, also assess whether there are opportunities to reduce the number of holdings in those portfolios. My “After” portfolios frequently feature index funds and ETFs because they provide pure asset-class exposure and a lot of diversification in a single package. In addition, I often employ multi-asset funds like target-date funds for smaller accounts to provide diversification without any maintenance obligations.

Step 7: Manage for tax efficiency.

If through the preceding research you’re convinced that some changes are in order, be sure to take tax and transaction costs into account. Focus any selling in your tax-sheltered accounts, where you won’t incur tax costs to do so, and you can usually skirt transaction costs, too. If you’ve identified problem spots within your taxable accounts, be sure to review the tax implications and/or get some tax advice before executing any trades.

While you’re thinking about taxes, spend some time reviewing whether you’re managing your portfolio with an eye toward tax efficiency. If you are making contributions, are you making them to your tax-sheltered vehicles? If you have taxable accounts, are those accounts as tax-efficient as possible? For a lot of people, this is as simple as holding equity ETFs and/or municipal bonds and bond funds for their taxable accounts. Finally, for people who are already in drawdown mode, it makes sense to think about tax-efficient withdrawal sequencing.

Step 8: Troubleshoot other risk factors.

Once you’ve conducted a thorough review of your portfolio, think about other risk factors that could affect your plan. A common one for many makeovers I conduct is uninsured long-term-care risk. This isn’t a big consideration for people who have a lot of wealth or for those who have very little; the former group will be able to self-fund, and the latter may need to rely on government resources for their care. (Indeed, Medicaid is the largest payer of long-term-care expenses in the United States.) Instead, it’s a significant risk factor for those whose finances put them between those two poles. Good answers are few and far between, but it’s still important to develop a plan in case you contend with sizable long-term-care outlays later in life.

Another common risk factor that doesn’t relate directly to a portfolio but nonetheless can have an outsize financial impact is providing financial help to loved ones, perhaps children or siblings who have financial needs or are disabled. In this case, it’s often helpful to seek the help of a financial advisor and/or estate planner to provide an objective opinion on how you can help effectively without jeopardizing your own financial future.

A version of this article was published on Oct. 28, 2021.