Happy New Financial Year- here’s 7 steps to review your portfolio
Review your portfolio and position yourself for the future
Editor’s Note: This article has been amended for an Australian audience
2024’s stock market has had a strong start. For the full financial year, the ASX 200 index was up 8%. Technology and financials led the charge, 29% and 23% up respectively. Consumer staples and energy dragged down the index.
We saw investors flooding back into bonds as yields rose but were still wary of duration. Many investors have also been getting decent enough yields from cash and fixed interest.
Overall, investors have had a solid year of investment returns across the board regardless of the perilous economic environment.
The outperformance of some asset classes would have shifted allocations within personal portfolios, and companies have been tested by trying economic circumstances and original theses may have to be revised on equity investments.
The new financial year is a good time to start reviewing your portfolio after a year of notable movements.
Step 1: Conduct a wellness check.
Start with an assessment of the state of 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 in the financial year: 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 (any eligibility for the Age Pension will be reduced), 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 tertiary education funding for children or a home down payment. In addition to assessing your savings rate, look at your portfolio balance. It’s important to construct your portfolio around a goal so you are able to gauge whether you are on track.
If you’re retired, the key gauge of the health of your total plan is your withdrawal rate—your portfolio withdrawals for FY2024, divided by your total portfolio balance at the beginning of the financial year. The “right” withdrawal rate will be apparent only in hindsight, and ideally you would vary your withdrawals each year based on how your portfolio has performed and your life expectancy. But the 4% guideline is a reasonable rule of thumb for new retirees, and our recent research points to its viability as a starting point for people seeking a fixed real withdrawal through retirement.
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 in Morningstar Investor—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. (Compare the allocation of the funds that correspond to your own anticipated retirement date with your own asset allocation.) My model portfolios, geared toward people who are saving for retirement as well as those who are already retired, can also help with the benchmarking process.
Thanks to the long-running rally, many hands-off 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 is fine 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. And it’s not like the alternatives are all that appealing right now, with cash and bonds yields still extremely low.
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. 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, now is a good time to check your liquid reserves. A dedicated emergency fund is of course the best option: 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.
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, or if both things happen at once, like in 2022. Retirees whose portfolios are equity-heavy can use rebalancing to top up their liquid reserves.
Cash yields have come up a lot, but make sure you’re getting a reasonable payout, as some banks and investment providers aren’t sharing the wealth. 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, especially because we’ve seen growth stocks beat value, large trump small, and US and AUS best most other markets over an extended period. Check your portfolio’s Morningstar Style Box exposure in X-Ray to see how your equity holdings are arrayed across the size/style grid. While you’re at it, check up on your sector positioning; X-Ray showcases your own portfolio’s sector exposures alongside those of the relevant benchmarks.
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. Lower-quality bonds have performed better than high-quality bonds during this period of rising interest rates, but lower-quality bonds also tend to be more vulnerable during weak economic environments when stocks are also struggling. 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 individual holdings.
In addition to checking up on allocations and suballocations, take a closer look at individual holdings. Scanning Morningstar’s 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 economic moat trends.
Also take note of highly appreciated positions that are taking up a larger share of your portfolio than might be ideal. (More than 5% of your total equity assets is a good benchmark for “too much.”) Company stock is a frequent culprit in this context. If you’d like to reduce, run some projections on how selling might affect your tax bill. If you're not conversant with the ins and outs of capital gains taxes, seek out the advice of a tax professional.
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. 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.