The following is an excerpt from Christine Benz’s recent webcast, Tune Up Your Portfolio in Uncertain Times. Watch the full webcast.
Christine Benz: Let’s move on to the issue of asset allocation. This is the next key step in the process of reviewing the personal asset allocation of your portfolio. A tool I’ve often been excited about for checking your portfolio’s asset allocation is our X-Ray feature on Morningstar.com. So, if you have a portfolio registered on Morningstar.com, you can click on the X-Ray tab to review the x-ray of your portfolio. There is also a tool called Instant X-Ray that you can find on Morningstar.com where you can add your portfolio holdings and you can see your total portfolio allocation. So if you go through this process, you will see a screen that looks like this with your asset allocation, laid out in a pie chart, which is what you see in the top left.
The cool thing about X-Ray is that it shows you your portfolio’s actual exposures to asset classes. So if you have mutual funds in your portfolio and actively managed mutual funds in your portfolio, it will crawl those portfolios and allocate your total exposure to the asset class accordingly. So if you have an international fund, for example, that holds US stocks, well, that will count towards your US weighting. If you have a high value fund that also holds high mix stocks or mid value stocks, this will show up in terms of your style box exposure. Thus, X-Ray is a good way to control your portfolio’s real exposures to asset classes. This is the starting point of this exercise.
The next step is to compare this asset allocation to your target allocation. And at this point, I think a lot of investors might say, “Wait a minute, I don’t have a goal.” And that’s absolutely fine. I think the key is to have your arms around something reasonable in terms of valuing your portfolio’s asset class exposures. So a really quick and dirty way to do that would be to look at a good target date fund for someone in your age bracket. So if you think you’ll retire in, say, 2040, look at some of the 2040 target date funds. We also have the Morningstar Lifetime Allocation Indices, which I often refer to. You can see aggressive, moderate, and conservative flavors from these indexes. I think this is another objective for evaluating your portfolio’s asset class exposures, just to see if you’re on the right track.
The problem with asset class exposures and their targets is that it’s really hard to find one-size-fits-all asset allocations. It depends on a lot of things. So it depends on your human capital, so your proximity to the need for your money, of course, but also quite simply on the volatility of this capital. If you are someone who is a commission salesperson, for example, you may have periods when you are relatively abundant, but you may also have periods when your income is not as high. This argues in favor of being a bit more conservative in terms of asset allocation. You also want to think about all of your assets, so not just your personal retirement assets, but whether you and your spouse are going to retire together and draw from the same portfolio. Looking at all of these assets together, I think, is a good way to assess asset allocation. But these are some rough metrics you can use to gauge the appropriateness of your asset allocation given your situation.
As investors consider their asset allocation exposures, one thing that might jump out at you is that you may be quite far from the goals you set for yourself. I think a good rule of thumb to keep in mind is that you want to rebalance your portfolio exposures if you’ve drifted 5 or 10 percentage points from your target allocations. So a portfolio that was 60% stocks and 40% bonds five years ago would now be over 70% stocks and about 30% bonds. So this hands-off portfolio has likely become more aggressive for many investors. Similarly, a portfolio that would not have been rebalanced between international and American would have seen its American component drift upwards. And then we talked about how value stocks had a really good run in 2021. That was a relatively new phenomenon. We have seen growth stocks outperform value by a large margin over the past five years. So that’s another part of your portfolio exposure to take a closer look at, if you need to rebalance growth towards value because non-intervention has probably made your portfolio heavier on equities, heavier on US stocks and heavier on growth stocks if you have it didn’t matter.
If you’re someone who uses the bucket system for your portfolio, and this is particularly relevant for people who are retired and in drawdown mode, I think the bucket approach can be a useful way to assess the suitability of your current asset-allocation mix. So in my basic Bucket setup, I’ve set aside two years of cash wallet withdrawals – so risk-free, risk-free with that part of the wallet. Bucket 2 represents another five to eight years of portfolio withdrawals. It takes a little more risk with this part of the portfolio, but not too much. Thus, this part of the portfolio is generally anchored in high-quality short and medium-term bonds, bond funds. You may have a small exposure to Treasury inflation-protected securities in this portfolio. You might have a hint of equity exposure. With those two buckets, you’re accounting for about 10 years of wallet withdrawals, about eight to 10 years, and that means if Armageddon happens in the stock market, you’ll basically be able to spend in that safe part of the wallet. without having to touch equity assets, and this is particularly important if the market continues to experience volatility. You would want to make sure your plan is set up so that you don’t have to touch impaired equity assets. And then assets for 10 years and beyond your portfolio withdrawals I believe can be safely parked in a globally diversified equity portfolio. But that’s the basic Bucket configuration. I think it’s useful to use as a sort of test of the viability of your asset allocation, whatever it is today.
If we wanted to translate this bucket system into an actual model portfolio – and I have many variations of these model portfolios on Morningstar.com – it would start with bucket 1, which would include two years of portfolio withdrawals. So, assuming we withdraw $60,000 from the portfolio per year, I would have $120,000 in cash investments. And then another eight years of portfolio withdrawals, so $480,000 of the portfolio would be in this generally high-quality fixed income portfolio. And then, finally, Bucket 3 is the long-term growth engine of the portfolio. This is generally a globally diversified equity portfolio. And here’s where I’d get a bit stuck – if I wanted to use some of the higher yielding types of fixed income securities, I’d put them in that part of the portfolio where I had a nice time horizon for them. So I think this framework can be helpful when thinking about the suitability of your retirement plan. Even if you don’t use a Bucket strategy, I think this can be a useful control regardless of your asset allocation.
Assess your retirement asset allocation
The Bucket Investors Guide to Setting Asset Allocation for Retirement