Editor's note: A version of this article appeared on Dec. 17, 2018.
"Stay the course."
"Stick with your asset-allocation plan."
"Focus on what you can control."
Those are worthwhile pieces of advice during market volatility like we've experienced recently. But they can ring a little platitudinous for some investors. How do they know if the course they're on is the right course? What if they don't know what their asset allocations are, let alone whether they're reasonable? And which factors do they actually control, and how can they control them?
To help investors address those questions and cope with the market volatility in a concrete and productive way, we've put together a Market Downturn Tool Kit. It outlines some worthwhile jobs to tackle during a downturn--or any time, really--along with the tools you need to get them done. Not only will knocking off those jobs give you more confidence in your plan--or at least focus your attention on the steps you need to take in order to get it in better shape--but it will also serve to distract your attention from activities that aren't helpful, like compulsively checking your portfolio balance or the S&P's minute-by-minute fluctuations.
Job: Check Up on the Reasonableness of Your Stock/Bond Mix
As markets have trended up for the better part of the decade, it has been easy to let equity winners ride. The net effect of that inattention is that untended portfolios have become progressively more equity-heavy and volatile: A portfolio that was 60% stock/40% bond 10 years ago would be more than 80% stock today. Thus, a key job for investors attempting to see if their portfolios are too risky is to assess their asset allocations. Morningstar's X-Ray functionality, accessible via Morningstar's Portfolio Manager or the Instant X-Ray tool, enables you to see how your portfolio is positioned today, taking into account the underlying holdings of the mutual funds in your portfolio. Armed with that information, you can then compare your data with that of a sensible benchmark. The Morningstar Lifetime Allocation Indexes are a good starting point; checking out your allocations relative to those of a good target-date fund geared toward your retirement date, such as the Vanguard Target Retirement and BlackRock LifePath Index series, can also be useful.
People who are retired or getting closer to retirement can use their own portfolio spending amounts to dictate a sensible asset-allocation framework. My Model Portfolios, which use the Morningstar Lifetime Allocation Indexes to shape their asset allocations, provide an additional tool for benchmarking the reasonableness of an asset allocation. Don't forget to check liquid reserves: My Bucket portfolios for retirees include one to two years' worth of portfolio spending needs in true cash instruments. For folks who are still working, three to six months' worth of living expenses in cash is a good baseline. High-income earners, contractors, or those with more specialized careers should shoot for a year or more of living expenses in cash reserves.
Job: See If Your Plan Is on Track
Many investors naturally wonder if an investment downturn is going to be so severe that it derails their plans. Will retirement--which seemed so close just a few short weeks ago--need to wait? Are there any ways to make a save?
The gold standard for getting a check on the viability your plan is to sit down with a fee-only financial planner. Before you do that, though, get clear on what kind of advice you're seeking, and also be sure to put any prospective advisors through their paces. There are also plenty of online tools available for do-it-yourself investors aiming to get their arms around whether their retirement plans are on track. I've long recommended T. Rowe Price's Retirement Income Calculator, but it's worthwhile to sample a range of opinions. The Bogleheads site includes a helpful compendium of retirement-planning calculators with links. For the truly time-pressed, Vanguard's Retirement Nest Egg Calculator and the Fidelity Retirement Score tool are worth checking out. All calculators require you to plug in some return assumptions; the key is to be realistic and not too aggressive.
To keep your plan on track on an ongoing basis, an investment policy statement is invaluable. You can customize yours to suit your own needs, but at a minimum, your document should state your investment goals (date, amount, duration), ongoing contribution amounts, basic asset-allocation framework, and what qualities you're seeking in your investments. Retirees and pre-retirees should also maintain a separate retirement policy statement that documents their withdrawal-rate system, among other key retirement-planning factors.
The Tool Kit Choosing a Financial Advisor: An Investor's Checklist T. Rowe Price Retirement Income Calculator Vanguard Retirement Nest Egg Calculator Fidelity Retirement Score Morningstar's Investment Policy Worksheet Retirement Policy Statement
Job: Check Up on Investment Quality
After you've assessed your portfolio's asset allocation and viability, take a closer look at the quality of the investments you've chosen to populate your plan. Of course, Morningstar.com features a dizzying array of data for stocks, mutual funds, and exchange-traded funds. Rather than being blinded by short-term gains (or losses), try to focus instead on the big picture. Do your holdings align with the qualities you've laid out in your investment policy statement (above)? Is your portfolio as streamlined as it can be, or can you identify redundancies? Do your holdings earn strong ratings from Morningstar's analyst team--medalist ratings for funds and ETFs, star ratings of 3 or better for stocks?
Job: Check Up on Your Spending
Investors are often exhorted to focus on what they can control when the markets are uncertain and volatile. At the top of the "In Your Control" list should be your savings and spending rates: How much you are able to invest on an ongoing basis will be by far the biggest determinant of when and whether you reach your financial goals. A strong market and enlarged portfolio balances can stoke a "wealth effect," making you more comfortable to spend than you otherwise would be. If you haven't done a budget recently, there are a host of online tools and apps for tracking your expenses on an ongoing basis. Alternatively, you can create a budget the old-fashioned way, using an Excel spreadsheet or other budget worksheet.
The Tool Kit Budget Worksheet
Job: Check Up on Investment Costs
Since we're on the topic of expenses, do you know what you're paying for your portfolio on an ongoing basis? Most investors don't, even though managing investment costs is one of the best ways to improve your take-home return. If you have a portfolio saved in Morningstar's Portfolio Manager, you can find valuable summary statistics about what you're paying in the Fees & Expenses section of the X-Ray overview: your average mutual fund expense ratio, the expense ratio of a similarly weighted portfolio with average expenses, and your total expenses in dollars and cents. If your portfolio's expense ratio isn't comfortably below average, click the X-Ray Details tab, then Fees & Expenses below that, to see how your holdings stack up relative to their category peers. The "Price" tab for individual mutual funds and ETFs provides a wealth of comparative and historical expense data.
Job: Check Up on Tax Efficiency
In a related vein, are you managing your portfolio with an eye toward reducing the drag of taxes? Are you taking maximum advantage of your tax-sheltered options? If you have taxable, nonretirement holdings, have you populated that portion of your portfolio with investments that limit taxable income and capital gains distributions?
By clicking on the "Price" tab of Morningstar.com's mutual fund and ETF reports, you can see a suite of tax-efficiency data that compares each holding to its peers. If you see a long-term tax-cost ratio of 1% or more, that's a red flag that a holding is a better fit for a tax-sheltered account. Bond investors can use the Tax-Equivalent Yield function of Morningstar's Bond Calculator to determine if municipal or taxable bonds are a better bet for their taxable accounts.
The Tool Kit Conduct a Tax Audit of Your Portfolio Tax-Equivalent Yield Calculator (compares taxable bonds with municipal bonds)