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A Year-End Portfolio Review in 7 Easy Steps

Check up on your portfolio’s health—and that of your whole plan—ahead of tax season.

As we reflect on 2022, it was very much an annus horribilis and an extreme turnabout from 2021, when most investors enjoyed their third straight year of big gains. Rising interest rates, the result of the Federal Reserve’s plan to tamp down inflation, led to dual routs in the stock and bond markets. Bright spots were few and far between. Investment types like energy stocks, commodities, and managed futures funds generated positive returns, but they tend to be light weightings in most investors’ portfolios.

If you’re a disciplined investor, you can use an annual portfolio review as a way to check up on your portfolio—and potentially make some changes—within the context of your well-thought-out plan. After all, even if you haven’t actively made changes to your portfolio mix, the contents of your portfolio may have shifted.

I like the idea of thinking of your annual portfolio review as an inverted pyramid, with the most important jobs on the top and the least important ones at the bottom. That way, if you run out of time and need to give something short shrift, you'll have attended to the most important considerations first.

Here are the key steps to take.

  1. Conduct a wellness check.
  2. Assess your asset allocation.
  3. Check the adequacy of your liquid reserves.
  4. Assess suballocations and troubleshoot other portfolio-level risk factors.
  5. Gauge inflation protection.
  6. Review holdings.
  7. Attend to tax matters.

Step 1: Conduct a 'Wellness Check'

Begin your portfolio checkup by answering the question: "How am I doing on my progress to my goals?"

For accumulators, that means checking 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 for the year: 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. You’ll also need to aim higher if you’re saving for goals other than retirement, such as college funding for children or a home down payment.

If your annual savings rate will fall short of what you’d like it to be, take a closer look at your household budget for spots to economize. In addition to assessing savings rate, take a look at your portfolio balance: Fidelity Investments has developed helpful benchmarks to gauge nest-egg adequacy at various life stages. (Also be sure to read Amy Arnott’s helpful discussion of the pros and cons of these benchmarks.)

If you’re retired, the key gauge of the health of your total plan is your withdrawal rate--all of your portfolio withdrawals for this year, divided by your total portfolio balance at the beginning of the year. The “right” withdrawal rate will be apparent only in hindsight, but if you’re just embarking on retirement, our recent research on withdrawal rates should provide good food for thought.

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.

Step 2: Assess Your Asset Allocation

Once you’ve evaluated the health of your overall plan, turn your attention to your actual portfolio. Morningstar’s X-Ray view—accessible to investors who have their portfolios stored in Morningstar Investor or via Morningstar’s Instant X-Ray tool—provides a look at your total portfolio’s mix of stocks, bonds, and cash. (You can also see a lot of other data through X-Ray, which I’ll get to in a second.) You can then compare your actual allocations to your targets. If you don’t have targets, the Morningstar Lifetime Allocation Indexes are useful benchmarking tools. High-quality target-date series such as BlackRock LifePath Index can serve a similar role for benchmarking asset allocation; focus on the vintage that roughly matches your anticipated retirement date. My model portfolios can also help with the benchmarking process.

Stock and bond performance were equally crummy in 2022, so many investors’ baseline asset allocations may not have budged too much this year. But investors who didn’t reduce their equity exposure during stocks’ long-running rally prior to this year may find that they’re still a bit heavy on stocks relative to their targets. A portfolio that was 50% stocks and 50% bonds three years ago would be 60% equities today, factoring in stocks’ recent selloff. That’s because stocks were so far ahead of bonds heading into 2022.

An equity overweighting isn’t a huge deal for younger investors with many years until retirement, and the risks of holding an equity-heavy portfolio have arguably gone down a lot along with stock valuations. But 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. (Be sure to diversify across bonds of varying maturities: The year 2022 demonstrated the pitfalls of focusing on intermediate- or long-term bonds for short time horizons. Use cash and short-term bonds instead.) 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.

Step 3: Check the Adequacy of Liquid Reserves

In addition to checking up on your portfolio's long-term asset allocations, your year-end portfolio review is a good time to check your liquid reserves. If you're still working, holding at least three to six months' worth of living expenses in cash is essential; higher-income earners or those with lumpy cash flows (looking at you, "gig economy" workers) should target a year or more of living expenses in cash.

For retired people, I recommend 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 as they have so far this year.

In addition to checking up on the amount of liquid reserves that you hold, also check up on where you're holding that money. Online savings accounts are usually among the highest-yielding FDIC-insured instruments, but money market mutual funds, which aren't FDIC-insured, offer you the convenience of having your cash live side by side with your investment assets. Yields on brokerage sweep accounts, which offer convenience for traders who like to keep cash at the ready, are often stingy on the yield front.

Step 4: Assess Suballocations and Troubleshoot Other Portfolio-Level Risk Factors

While value stocks held their ground better than growth in 2022, growth stocks still trumped value over longer time periods. That means your portfolio may still be heavy on growth stock, too. Check your portfolio’s Morningstar Style Box exposure in X-Ray to see if it is tilting disproportionately to growth names. While you’re at it, check up on your sector positioning; X-Ray showcases your own portfolio’s sector exposures alongside those of the S&P 500 for benchmarking.

On the bond side, review your positioning to ensure that your bond portfolio will deliver ballast when you need it. Yes, high-quality bonds and bond funds have taken a hit so far this year, but they’ve often gained in value during recessionary periods when stocks have tumbled. Indeed, they’ve recently rallied because of signals that the economy is slowing.

Step 5: Gauge Inflation Protection

Inflation was a nonissue for the better part of the past decade, but it surged in 2022. If you’re still working, eligible for cost-of-living adjustments to your salary, and have ample stock exposure in your portfolio, there’s no pressing reason to add in a lot of inflation protection. On the other hand, retirees with healthy shares of their portfolios in fixed-rate investments are more vulnerable, in that inflation gobbles up the purchasing power of their meager yields. Treasury Inflation-Protected Securities and I Bonds help address that risk by offering an adjustment to account for inflation. I like to group inflation-defending investments into a few key categories: broad basket (TIPS), more narrowly focused (commodities, real estate), and what I call “inflation beaters” (stocks).

Step 6: Review Holdings

In addition to checking up on allocations and suballocations, take a closer look at individual holdings. Scanning Morningstar’s qualitative ratings—star ratings for stocks and Morningstar Medalist ratings for mutual funds and exchange-traded funds—is a quick way to view a holding’s forward-looking prospects in a single data point.

If you're conducting your own due diligence, be on alert for red flags at the holdings level. For funds, red flags include manager and strategy changes, persistent underperformance relative to cheap index funds, and dramatically heavy stock or sector bets. For stocks, red flags include high valuations and negative moat trends.

Step 7: Attend to Tax Matters

Year-end is also your deadline for several tax-related to-dos, some of which touch your portfolio. If you’re still in accumulation mode, review how much you’re contributing to each of the tax-sheltered account types that are available to you: IRAs, company retirement plans, and health savings accounts. Contribution limits for 401(k)s, 403(b)s, and 457 plans will be increasing a bit in 2023, to $22,500 for workers under age 50 and $30,000 for workers who are 50-plus. The IRA contribution limit is staying the same—$6,500 for investors under age 50 and $7,500 for investors who are over 50.

In addition, retirees must take required minimum distributions from tax-deferred accounts before year-end. I'm a big believer in taking a surgical approach to RMDs, using those withdrawals to correct portfolio problem spots. Charitably inclined investors who are age 70.5 or older should take advantage of what's called a qualified charitable distribution.

Finally, down markets like 2022′s offer a silver lining in the form of tax-saving opportunities, including tax-loss selling and converting depressed Traditional IRA balances to Roth with relatively low tax consequences. Booking tax losses can reduce the taxes due on taxable accounts, and converting IRA balances can help provide more control over tax bills in retirement.

Versions of this article previously appeared in December 2021 and December 2022.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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