Midyear Portfolio Checkup in Five Steps

Many of the basic rules of investing are counterintuitive. For example, rising interest rates may be good news for those shopping for certificates of deposit and other short-term savings vehicles, but they're generally bad for bond funds. And here's another zinger: The lazy investor is often more successful than the hard-working one.

Christine Benz 20.07.2009
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Many of the basic rules of investing are counterintuitive. For example, rising interest rates may be good news for those shopping for certificates of deposit and other short-term savings vehicles, but they're generally bad for bond funds. And here's another zinger: The lazy investor is often more successful than the hard-working one.

If you're checking in on your portfolio holdings every day--or worse yet, throughout the day--you may be tempted to trade more than you need to. In turn, you may run up high tax and transaction costs, and you're also more likely to chase hot-performing stocks and funds in the hope that they'll continue to outperform. That can be a recipe for disaster.

Because it is possible to shoot yourself in the foot with overzealous trading, I'm a big p

roponent of conducting a portfolio review just a few times a year--semiannually or quarterly. The purpose of this portfolio checkup is to systematically troubleshoot problem spots and identify changes you may want to make as part of your rebalancing program. (You should plan to rebalance your portfolio--remove money from those investments that have performed well and plow it into your portfolio's underachievers--at least every few years.)

Observe the following five steps as you conduct a review of your portfolio. Take notes as you go along, because you'll want to refer to them when you rebalance.

1. Make sure your asset mix is in line with your target.
One of the most important determinants of whether your portfolio is positioned to meet your goals is your asset allocation--how much you hold in stocks, bonds, and cash. To help get a precise read on how your portfolio is currently positioned, check out Morningstar's Instant X-Ray tool, free to all users of Morningstar.com. Enter a ticker for each of your holdings (don't forget company stock and cash!), along with the dollar value for that holding, then click Show Instant X-Ray. You'll see a pie chart depicting how much you have in each of the major asset classes, which you can then compare with your target allocations. Many U.S. stock managers are scooping up foreign stocks, so your portfolio's overseas holdings may have increased. That's not a bad thing, but it could signal that you don't need to add more dedicated foreign-stock exposure to your portfolio.

But what if you don't know how much you should have in stocks (U.S. and foreign), bonds, and cash? If that's the case, check out Morningstar's Asset Allocator tool to arrive at an asset-allocation framework that makes sense given your own particular circumstances.

2. X-ray your portfolio.
Once you've assessed your portfolio's asset allocation, turn your attention to how your stock and bond holdings are positioned. Within Instant X-Ray, you can see stock and bond Morningstar Style Boxes (two nine-square grids in the upper right-hand corner of the X-Ray page) that depict the investment styles of your holdings. While you shouldn't expect to see an even distribution of holdings in each of the nine squares, you do want to take note if the majority of your holdings are huddled in one or two regions of the style box.

Instant X-Ray also shows you how your stock holdings are dispersed across various market sectors, as well as how that positioning compares with the S&P 500 Index's sector weightings. As with style-box positioning, you shouldn't get too worked up about some divergences, but you do want to take note of very big bets--sectors where your weighting is more than twice that of the index, for example. If you need help interpreting whether your portfolio's style and sector bets are notable or not, click on X-Ray Interpreter for a written explanation of what's notable about your portfolio's current positioning.

Finally, click on Stock Intersection, also on the main X-Ray page, to see whether your portfolio is disproportionately skewed toward one or two individual stock holdings. This is a good way to tell whether company stock is hogging a disproportionate share of your portfolio. (As a general rule of thumb, company stock should take up less than 10% of your total holdings.)

3. Review your individual holdings.
Once you've checked out your aggregate portfolio's positioning, it's time to conduct a quick checkup on each of your individual holdings. At the bottom of the Instant X-Ray page, you'll see links for each of your funds or stocks; click on the links to see a detailed report for each.

Morningstar's Analyst Reports--free to Morningstar.com Premium Members--are a quick and easy way to get a handle on the key issues at most prominent mutual funds, exchange-traded funds, and publicly traded companies; our analysts will also tell you whether they think a security is worth owning or not.

If you'd like to conduct your own research on your holdings, you'll need to drill down into the data. For funds, take note of any manager changes, strategy alterations, or upheaval at the fund-company level. (A lot of fund shops have changed hands over the past few years.) As you assess individual stocks, take note of price multiples and profitability trends; Premium Members can also see a Morningstar Rating and fair value estimate for all stocks covered by our analysts.

4. Examine performance.
It's a big mistake to focus too much attention on short-term performance, but your quarterly or semiannual portfolio review should include a quick assessment of which of your holdings are providing the biggest boost to or drag on your portfolio's overall return. It's fine to glance at year-to-date performance, but focus most of your attention on the longer-term numbers--each holding's return over the past three and five years relative to that of other offerings within that same category. Also take note of absolute returns. Which of your holdings have contributed the most--or detracted the most--from your portfolio's bottom line? Sustained underperformance can be an indication that something's seriously amiss with one of your holdings. But assuming that your rationale for buying a stock or fund is still intact, a spate of weak returns can also provide you the opportunity to add to that holding on the cheap when you rebalance later this year.

5. Plan your next move.
After you've reviewed your portfolio's current status, it's time to plan your next move. It's not likely that you'll uncover a portfolio problem you need to address right away, but you should make sure to schedule a time to rebalance your portfolio. Conventional financial-planning wisdom holds that the best time to rebalance is at year-end, with an eye toward harvesting any losses to offset capital gains elsewhere in your portfolio. But if you'll have more time to focus at some other time of the year--say, earlier in the fourth quarter--by all means do so.

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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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