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A Midyear Portfolio Checkup in 7 Steps

After the first-quarter market volatility, the time is right to see if any adjustments are in order.

If you didn't any make any panicked trades in the midst of the first-quarter stock market downdraft, give yourself a pat on the back. Amid the pandemic and related economic worries, stocks experienced some gut-wrenching drops in February and March 2020, testing the fortitude of even the most battle-scarred investing veterans. Stocks went on to enjoy a dramatic recovery in the second quarter, nearly erasing their first-quarter losses and rewarding investors who sat tight through those scary days.

Now that the markets have calmed down, it's a much better time to check up on your portfolio than was the case when everything was topsy-turvy. With a cooler head, you can methodically see if any adjustments are in order. I usually say that conducting such a review once or twice a year--or quarterly, at most--is more than enough for most investors. As you do so, follow these seven steps.

Step 1: See how you're doing. Before you get mired in the details of your portfolio, start with your plan. Are you on track to reach your 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 2020: 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. 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.

If you're retired, the key gauge of the health of your total plan is your withdrawal rate--your planned portfolio withdrawals for 2020, divided by your total portfolio balance at the beginning of the year. The "right" withdrawal rate will be apparent only in hindsight. The 4% guideline is often held out as a good starting point, having been stress-tested over a variety of time periods. However, some retirement experts argue that today's low bond yields argue for an even lower starting withdrawal rate. The year 2020 hasn't provided many opportunities to splurge (understatement!), but if you've had a big-spending first half for one reason or another, there's still time to rein it in so that your 2020 withdrawal rate comes in at a comfortable level.

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 on 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 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.

Although the first quarter was rough, stocks regained a lot of ground in the second quarter. That means that many investors are apt to find that their portfolios are quite heavy on stocks relative to the above benchmarks. A portfolio that tilts mostly or even entirely toward stocks isn't a huge deal 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 usually makes sense to maintain as high an equity allocation as you can tolerate.

But a too-heavy equity portfolio is a far more significant risk factor for investors who 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. From that standpoint, you can view the first-quarter market shock as a wake-up call to make some adjustments. 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 3: Assess adequacy of liquid reserves. In addition to checking up on your portfolio's long-term asset allocations, midyear is a good time to check your liquid reserves. If you've suffered an income reduction amid the pandemic--and many workers have--it's wise to think through your options if you'll need to tap your portfolio for additional funds for living expenses. A dedicated emergency fund is of course the best option: That's why I recommend that working people hold three to six months' worth of living expenses in liquid reserves, and higher-income workers and contractors/gig economy workers should target an even higher cushion. It's also worth nothing that the CARES Act passed this spring opened up additional alternatives for people who have suffered coronavirus-related hardship.

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.

In addition to checking up on the amount of liquid reserves that you hold, also check up on where you're holding that money. Cash yields have declined to a pittance in 2020's first half, but it's still worth shopping around for better rates. 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 your equity positioning. 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. In keeping with a pattern we've seen for several years running, domestic growth stocks and funds have still outperformed value names by a wide margin thus far in 2020. Check your portfolio's Morningstar Style Box exposure in X-Ray to see if it's tilting disproportionately to growth names. As a benchmark, a total U.S. market index fund holds roughly 25% in each of the large-cap squares, 6% apiece in the mid-cap boxes, and 2% in each of the small-cap boxes. Not every portfolio has to be right on the top of the index, but the style-box view lets you see if you're making any big inadvertent bets.

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. 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.

Step 5: Evaluate your fixed-income exposures. On the bond side, review your positioning to ensure that your bond portfolio will deliver ballast when you need it. Thus far in 2020, the safest bond funds have held up best, whereas riskier bond-fund types are still clawing their way back from big losses in the first quarter. Of course, yields on high-quality bonds are incredibly low today, but their relative and absolute year-to-date strength demonstrates, yet again, that the most boring, highest-quality bonds will tend to hold up best in market shocks. If you're adjusting your fixed-income portfolio, redeploying money from higher-risk bond segments into lower-risk alternatives will improve your total portfolio's diversification and risk level, even as it's likely to lower the yield. To the extent that you make room for lower-quality bonds, think of them as equity alternatives, not bond substitutes.

Step 6: Check up on your holdings. In addition to checking up on allocations and suballocations, take a closer look at individual holdings. Scanning Morningstar's qualitative ratings--Morningstar 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: Make changes judiciously. Whether you act on any of the conclusions you drew from your fact-finding in Steps 1-6 depends on a couple of factors--the type and severity of the issue, as well as your life stage and situation and the parameters you've laid out in your investment policy statement. (If you don't have an IPS, you can use a template to create one.)

If you're many years from retirement, tend to be unruffled by market volatility, and your portfolio has 90% in stocks even as many asset-allocation benchmarks suggest 80% or 85% for people at your age, repositioning your long-term portfolio probably isn't urgent. But if you do decide to make changes, 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.

Making changes can be more pressing if you're getting close to or in retirement, especially if your portfolio is too aggressively positioned and you don't have enough in safe assets to tide you through sustained weakness in the stock market. In that case, it's wise to think about redeploying some of your enlarged equity portfolio into cash and bonds.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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