Portfolio Checkup

Adam M. Grossman

THE STOCK MARKET hit a milestone last week, surpassing its pre-coronavirus all-time high. There’s a lot of debate about whether this is justified or sustainable. But the bottom line is, your portfolio today probably looks very different from the way it looked six months or a year ago. This may be a good time to take stock of what you own and to consider whether changes are warranted.

Back in February, I talked about the importance of asset allocation—and that’s a critical first step. Research suggests asset allocation explains 90% or more of a portfolio’s return. But asset allocation isn’t the only consideration. It’s also important to evaluate your portfolio’s individual holdings. But how? If your portfolio is what I call a “broker’s special”—a jumble of individual stocks, bond funds, exchange-traded funds (ETFs) and more—what’s the best way to make sense of what you own? Try this seven-step process:

Step 1: X-Ray

A great online resource is Instant X-Ray, provided at no charge by the investment research firm Morningstar. Just enter the names of each of your investments, along with the dollar amount of your holdings, and Instant X-Ray will return a dozen pages of analysis. With your report in hand, these are the sections I’d review first:

  • Style. Morningstar uses a nine-square “style box” grid to illustrate the breakdown of a portfolio along two critical dimensions: You’ll see how the stocks in your portfolio fall along a spectrum from large-cap to small-cap, and you’ll see how they fall along a spectrum from growth to value. Morningstar knows what stocks are held by every mutual fund and ETF. Result: No matter how many different funds and stocks you own, your X-Ray report will show you exactly what you hold on a consolidated basis.
  • Sector. This section will show you the composition of your stock portfolio—including the underlying holdings in your mutual funds—by industry sector, such as technology, health care, utilities and so on. It will also show you how the breakdown in your portfolio compares to the S&P 500’s breakdown.
  • Geography. Whether you should hold international stocks—and to what degree—is a crucial question. As a starting point, it’s important to know where your portfolio stands today.

Step 2: Oddballs

As I’ve noted before, there are lots of ways you can invest your money. But in my view, there are really only four worthwhile investments: stocks, bonds, real estate and cash. That’s why you’ll want to comb through your portfolio looking for oddballs—holdings that don’t fit into one of these straightforward categories. Some oddballs I’d keep an eye out for:

As we’ve seen this year, the stock market and even the bond market are unpredictable. Why make your life harder with one of these Wall Street creations?

Step 3: Concentration

There’s been much talk lately about the disproportionate success of a small number of stocks—Apple, Amazon and so forth. Do you own shares in these companies? If so, that’s great. But you also want to be careful. If a modest holding in one or more of these companies has ballooned over time and now represents a large portion of your net worth, that’s important to know. Fortunately, this is another area where your Instant X-Ray can help. Look for the “Top 10 Holdings” section of the report.

Step 4: Costs

The investment industry takes advantage of what I like to call the law of small numbers. By pricing their funds in percentage terms, rather than in dollar terms like any other business, fund companies make their fees look small and innocuous. In reality, though, many funds’ fees are unnecessarily high.

Fortunately, the trend toward index fund investing has put downward pressure on fees industrywide. That’s a good thing—but you still want to audit your portfolio carefully. X-Ray reports include expense information. You can also check fund fees on many finance websites.

For most funds and ETFs, this should be easy. But if you own more complex vehicles, such as an annuity or a whole life insurance policy, you’ll have to dig a little more. I suspect it’ll be worth the effort. In my experience, the harder it is to figure out what a financial product charges, the higher the cost turns out to be.

Step 5: Tax-efficiency

In an earlier article, I detailed a process for evaluating the tax efficiency of a mutual fund or ETF. I’ve found tax efficiency to be one of the most overlooked aspects of an investment portfolio. But with tax season recently completed, this is a perfect time to tackle this issue.

Step 6: Benchmark

A while back, a fellow investment analyst made a simple but insightful comment: “What the hell does the S&P 500 have to do with my goals?” It was a good point. The S&P 500 is, more often than not, viewed as the gold standard against which all investments are measured. But this isn’t the only way to achieve your financial goals. In fact, academics have found that it takes only 30 or 40 stocks to build a portfolio that’s sufficiently diversified.

If your portfolio is well-diversified but simply looks different from popular benchmarks like the S&P 500 or the Dow Jones Industrial Average, it’s important to ask whether that really matters. This is a somewhat subjective question—but one that’s crucial to consider before reflexively selling an investment.

Step 7: Bonds

The above steps have focused mainly on stocks. That’s because stocks, in general, carry much more risk than bonds. But don’t overlook the bonds and bond funds in your portfolio. X-Ray reports include a section on bonds, and you’ll definitely want to pay close attention. After all, bonds these days offer little in the way of income. Their only appeal is that they promise to return your principal in full. Audit your bond portfolio to be sure you’re comfortable that all your holdings will be able to fulfill that promise.

After conducting the above exercise, you may identify one or more investments that don’t make the cut. If selling those investments would leave you with a tax bill, should you sell or leave well enough alone? Stay tuned. I’ll address that question next week.

Adam M. Grossman’s previous articles include Don’t Feel BadMinimizing Regret and Don’t Be That Person. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.

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