(PUB) Morningstar FundInvestor

16

Cutting a Huge Portfolio Down to Size Portfolio Matters | Christine Benz

The “Before” Portfolio Catherine’s portfolio is more sprawling than most. She currently has 50 distinct positions, not counting her cash and I-bond holdings. That’s a big port- folio, particularly when you consider that she has invested exclusively in mutual funds rather than individual stocks. Her portfolio has a 45% equity weighting ( 34% domestic , 11% foreign ) with 27% in cash (including her stable-value holdings in her 401 (k)) and another 27% in bonds . Her bond portfolio, meanwhile, encompasses a broad cross-section of securities, including Treasuries and Treasury Inflation-Protected Securities; corporate bonds, including high yield; international bonds; municipal bonds; and bank loans. Despite the obvious portfolio sprawl, which Catherine herself cites as an issue, she’s doing a lot right. Importantly, her savings habits are strong: She con- tributes the maximum allowable amount to her Roth IRA and HSA and puts another $ 18 , 000 per year into her 401 (k), including contributions from her employer. She has also generally selected low-cost funds. In large part because of her portfolio’s big em- phasis on inexpensive exchange-traded funds, her holdings have an average expense ratio of 0 . 36% per year. Finally, Catherine has made good use of the basic principles of asset location, stashing tax- inefficient assets such as higher-yielding bond types and REIT s inside her tax-sheltered accounts. The “After” Portfolio I tried to address a few key issues with the portfolio makeover. First, I aimed to arrive at an asset alloca- tion that makes sense given her time horizon, providing for short-term income needs for her early- retirement years as well as growth potential to accommodate a long and active retirement. Second, I wanted to dramatically reduce her number of hold- ings to simplify the task of overseeing her total port- folio as well as to ensure that her portfolio has adequate exposure to core asset classes. Finally, I wanted to make sure that Catherine had the right types of assets within each of her accounts, factoring in the expected time horizon for each pool of money, tax efficiency, and the availability of funds in each account wrapper.

“I’m 56 , single, and have $ 1 million saved. But I fear it’s nowhere near enough, and I wish I could work forever but know that at my age layoffs come out of nowhere.” So began Catherine’s email requesting a portfolio makeover. As is the case for many people who have invested for many years, Catherine, a media profes- sional, has money in several pools, including a 401 (k), Roth IRA , and multiple taxable brokerage accounts, including one managed by a financial advisor. “My money is all over the place!” she lamented. Catherine is luckier than most, however, in that she’ll be able to draw upon a pension during retirement that will provide $ 25 , 000 in income per year. Social Secu- rity will provide another source of in-retirement income, though she hopes to delay receipt until age 70 , at which time she expects to receive about $ 36 , 000 a year. Catherine’s main goal is to make sure that the total asset allocation of all of her accounts is on the right track. Although she’s pleased with the growth in her portfolio as equities have rallied recently, she knows that at this life stage, it’s wise to start taking risk off the table. Catherine said she’d also like another set of eyes on the fund choices she’s made, including guid- ance on whether she can cut any deadwood from her portfolio of 50 distinct holdings. Catherine would like to work until she’s 65 or 67 , but given the downsizing that has confronted her indus- try, she is bracing herself for the possibility that she’d need to tap her portfolio earlier than that—in a worst-case scenario, within the next few years. Thus, she’s balancing two key financial considerations: growing her assets for a long and happy retirement and the possibility that retirement could arrive before she’s truly ready for it.

Welcome to our new feature, Portfolio Matters, by Christine Benz, Morningstar’s director of personal finance. We’re thrilled to have Christine help you manage the port- folio challenges that you face each month. Christine will address personal finance issues with prac- tical solutions throughout the year.