The time comes every year to schedule your regular visit with your doctor and dentist. Sure, these appointments aren't our favorite day of the year, but an annual physical or oral checkup provides valuable insights into your health, informing you of changes your body needs, and hopefully, lets us know we're maintaining good health.
The same goes for your investments. A portfolio checkup is a thorough review of your nest egg to ensure little problems don't grow into big ones. Give your portfolio its checkup for 2019 this month and make any adjustments so you can take advantage of today's growing market. Then make it a habit, diligently reviewing your progress when next February rolls around. When you sit down to conduct your portfolio checkup every year, review these four investment vital signs.
An annual portfolio checkup can help ensure that your investments get a clean bill of health. Image source: Getty Images.
1. Performance
Your investments should provide a reasonable rate of return above taxes and inflation, growing your money so you can ride off into the sunset in retirement. Reviewing the performance of your investments is a good first step in a portfolio checkup.
By now you should have all your year-end investment statements handy, so you can pull them together to review last year's performance. Evaluate how your underlying investments -- stocks, mutual funds, and exchange-traded funds -- did relative to their benchmarks. For instance, if you owned an international fund last year, you can check its performance against a relevant benchmark like the EAFE Index, which covers Europe and Asia. You wouldn't want to compare an international fund to the S&P 500, because it wouldn't be an apples-to-apples comparison.
When reviewing the performance of any mutual funds you own, it's good to look not only at the most recent calendar year, but the past three and five years. This will give you a better idea of the fund manager's overall track record. If a manager has underperformed for more than a year, that's a cause for concern. There are too many other funds out there to stick with an underperforming manager for too long. If there's a consistent pattern of underperformance beyond one year, consider a change.
Calculating an annual return for stocks is a little more complicated, but once you do it -- assuming your stocks are all domestic -- you can compare your performance to the S&P 500 or the Wilshire 5000. The Wilshire 5000 is a broader index than the S&P 500, and it incorporates more stocks, as well as smaller-sized companies; it's a good benchmark if you have small, midsize, and large-cap stocks in your portfolio.
If your stock ideas have underperformed the broader market indices in 2018 and for several years prior, it may be time to consider outsourcing some of your portfolio to an active mutual-fund manager -- or simply to buy a low-fee fund that tracks an index instead. This way you can continue buying and selling your own stocks, but you can be assured some of your money will mimic the market's performance.
If you have an underperforming fund, but the investment has large embedded taxes, and selling would make you realize the tax, check your prior year's income tax returns to identify any loss carryforwards, or other losses in your portfolio you could use to offset the gain. You could also donate the stock or fund to charity, and move on: There is no taxable event if you give appreciated property to a qualified charity.
2. Asset allocation and diversification
Poor diversification and unsuitable asset allocation are major reasons that portfolios fail to deliver consistent returns.
Investors who forget to check their portfolio weightings over time may become top-heavy in one particular stock, fund, or sector that's growing. This may be fine in good times, but it can hurt you if the market corrects. December's 9% market drop was an unwelcome reminder of how important it is to make sure your asset allocation (the mix of stocks and bonds) is where you want it. Bonds won't give you much upside, but they can help mitigate losses in a market sell-off.
Your portfolio checkup should also include a review of the diversification: the mix of different styles of investing, or different types of holdings.
For instance, there are both "value" and "growth" styles of investing. Value stocks tend to be more dividend-oriented, whereas growth stocks are of companies more concerned with gaining market share and typically forgo dividends and reinvest their cash into research and technology instead of giving vash back to shareholders, in the hopes of growing larger and delivering bigger profits to shareholders down the road.
Here you'll want to check to see whether one style of investing -- value or growth -- accounts for a much larger percentage of your holdings than the other. Last year, growth stocks beat value, so given their outperformance, investors may now own more growth stocks. If you are OK with being skewed more to growth that's fine, but you should know your exposure. Growth and value stocks typically go in and out of favor, with no clear winner over time; if you don't want to guess which style will outperform, you can own both equally.
A portfolio checkup should also group the stocks you own by market capitalization, or size as measured by stock price times outstanding shares. Small cap companies are generally more risky, which could mean more return over time. Check to make sure the percentage you have allocated to small-cap stocks, relative to large and mid-cap stocks, is in line with your risk tolerance (ability to withstand loss). If you're comfortable with your portfolio fluctuating more, then some small-cap stocks may be a good fit for you. I like to keep small caps at around 20% of my equity exposure -- 10% in small-cap growth and 10% in small-cap value.
Make sure that other investments, such as bonds, are also diversified. Different types of bonds react differently to changes in the economy and interest rates. A diversified bond position may include a mix of municipal bonds in taxable accounts, inflation-protected bonds, corporate bonds, and perhaps even international bonds.
Now is also a good time to check the duration or maturity of your bonds. Many investors own only short-term bonds, because they move less if and when the Federal Reserve raises interest rates -- but this also means a smaller yield, as short-term bonds pay less than intermediate-term bonds. The Fed left rates alone in its last meeting, so this may be a time to shift more into intermediate-term bonds, to add yield to your fixed income.
3. Fees and expenses
If there's anything that can eat into your returns, it's fees and expenses. Be aware of how much you're paying in mutual-fund fees. You can find the mutual fund's expense ratio via it's prospectus, check the fund's website, or enter the fund's ticker on just about any financial website.
Mutual funds usually offer different share classes for the same fund. For instance, Vanguard's Admiral funds are cheaper than its Investor share class, though the Admiral has higher minimums. If you find that a mutual fund in which you already own shares has a cheaper share class, you should inquire to see if you're eligible; if so, you can request a share conversion by contacting the fund company, or the custodian where your money is held. A share conversion is not a taxable event; you're simply swapping a higher-cost share class for a lower-cost one.
To help keep costs down, consider no-load mutual funds. Companies like T. Rowe Price, Dodge and Cox, and Vanguard provide some very good mutual funds without the heavy loads or fees charged by some other companies.
Exchange-traded mutual funds (ETFs) are well-known for having low fees, generally because they don't require active management. An ETF is usually a static portfolio owning a basket of stocks in a particular segment of the market (for example, a healthcare ETF owns healthcare stocks across all of its subsectors). ETFs are a great way to own a particular slice of the market and buying the ETF corresponding to your intended market, like technology or healthcare, will give you good exposure to stocks in the sector at a low cost.
Most international funds are more expensive, so that's an area where you may want to consider an index fund or ETF to bring down costs. Certain active bond funds can be expensive -- in the bond world, charging more than 1% in fees is egregious and you shouldn't do it. When your yields from fixed-income returns might be tight, buying individual bonds, no-load bond funds or index funds may help keep costs down and improve your bottom line.
4. Beneficiary designations
Last but certainly not least: Be sure to check that the beneficiaries of your accounts are current.
There are some well-known beneficiary no-nos, such as divorced account owners who keep an ex-spouse listed as the beneficiary -- which could cause serious animosity and unfortunate bickering. This mostly goes for retirement accounts like IRAs and 401(k)s, as those assets flow via beneficiary designation rather than by a will. A retirement account can have a trust as a beneficiary to further protect the asset from creditors and lawsuits if that's a concern. You'll most likely want to name a spouse or child as a retirement account beneficiary, so they can roll the money over to their own retirement account and continue the tax deferral.
Be sure to name contingent beneficiaries as well; those individuals become the primary beneficiary only if the primary predeceases the contingent. For example, you could name your spouse primary beneficiary of your IRA, and your two kids each as 50% contingent beneficiaries.
Taking care of your portfolio
Luckily, a portfolio checkup is not as painful as, say, going to the dentist, but it does take time and work. The key is to do a thorough job on this now, so you don't have to worry about it again until next February. Double-checking all the parts of your portfolio helps you dodge pitfalls later and keeps your investments moving in the right direction.
Finally, make this checkup a habit. Like scheduling an annual physical every year, giving your portfolio an annual checkup is a good practice to get into, so make your first appointment today!
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