A Fourth-Quarter Portfolio Checkup in 4 Simple Steps

'Tis the season to review your stock/bond mix, check your portfolio's risk level, and see how you did.

Christine Benz 13.12.2013
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As stocks have soared so far in 2013, it's hard to blame investors for checking up on their portfolios more frequently than usual. After more than a decade's worth of financial crises and market shocks, it's comforting to see portfolio balances headed in the right direction.

Soaring portfolio balances and steadying home values can stoke the so-called wealth effect, prompting investors to spend more than they should because their financial assets look better on paper. And let's face it, the kind of rally we've had so far in 2013 can also stoke greed, prompting investors to chase hot-returning stocks and funds and to take risks they'd normally avoid.

My advice is to be disciplined and surgical in your portfolio checkups, focusing on the fundamentals of your holdings--especially your asset allocation--as well as other factors that are within your control.

As you assess your portfolio's positioning in late 2013, here are the key steps to take.   

Step 1: Assess your asset allocation.
Because your stock/bond/cash mix will be the most important determinant of how your portfolio behaves, assessing on your asset allocation should be the first step in any portfolio review. If you have a portfolio saved in Morningstar.com's Portfolio Manager, Morningstar's X-Ray functionality can provide a quick read on its breakdown. (If you have multiple portfolios geared toward the same goal, this article discusses how to collapse them into a unified whole for monitoring purposes.)

For those who don't have a portfolio saved on Morningstar.com, our Instant X-Ray tool provides a quick and dirty way to enter your holdings and check up on the portfolio's allocations. You can then compare that asset-allocation breakdown to the targets you've laid out in your Investment Policy Statement. If you don't have asset-allocation targets, this article discusses how to set your framework.

In many years, you might find that no asset-allocation shifts are in order. But as we wind down 2013, most investors are apt to find that their portfolios are heavier on stocks than they intended. This article discusses the case for lightening up on equities, while this one provides some strategies for derisking your portfolio immediately without subjecting it the threat of interest-rate-related shocks.

Step 2: Troubleshoot your suballocations, especially noncore bond exposure.
Getting your arms around your portfolio's weightings in the major asset classes is job number one, but don't neglect your portfolio's suballocations. Morningstar's X-Ray functionality can help you review the reasonableness of your sector weightings versus the S&P 500; you can also use the sector lens of Morningstar's Market Fair Value Graph to help you determine whether the sectors you're most heavily invested in look cheap or dear. For a check on your Morningstar Style Box exposure, the style-box weightings of a total market index fund like this one can provide a baseline.

Assessing your portfolio's fixed-income exposures is a trickier task but no less important, as asset flows show that investors have been gravitating toward risky bond types during the past year. Calculate your portfolio's ratio of core to noncore fixed-income types; by core I mean funds with high-quality bonds or those that land in Morningstar's short- or intermediate-term bond, government-bond, or municipal-bond categories. A handful of multisector funds also qualify as core holdings, but most do not. If you find that you have upward of 25% of your bond assets in noncore bond types, chances are you're taking too much risk with your bond portfolio, as I discussed here.

Step 3: Assess adequacy of liquid reserves.
In addition to checking your portfolio's allocations to stocks and bonds, also review your liquid holdings. For people who are working, three to six months' worth of living expenses in certificates of deposit, money market funds, and checking and savings accounts is still a reasonable target, while retired folks should shoot for one to two years' worth of living expenses in cash instruments. Don't count cash that happens to appear in your otherwise long-term holdings, such as stock and bond funds, and also resist the urge to venture into noncash alternatives. Yes, it's possible to pick off slightly higher yields with short-term bonds, but you'll also risk principal stability.

Step 4: Benchmark your performance.
In a good year for the market like 2013, it's easy to feel like a genius. But rather than resting on your laurels (or beating yourself up for not beating the S&P 500), be sure to check your portfolio's performance relative to a relevant benchmark. A target-date fund geared toward someone in your age band can stand in as a reasonable performance measurement, or you can check your performance relative to a custom-crafted benchmark, as discussed in this article.


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About Author

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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