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A Mid-Year Portfolio Check-Up in 5 Steps

Here are a handful of tips for allocators, bargain-hunters and the tax-averse for the second half of the year

Christine Benz 3 July, 2012 | 12:40PM

"Uh-oh. Here we go again." 

That's what many investors have likely been thinking during the past few months, as extreme market volatility has evoked memories of last summer and the spring before that. With concerns over Europe and slowing global growth taking centre stage, good days in the market have been followed up by more than a few bad ones.

As we close out a lacklustre quarter in which the FTSE 100 lost 3.4% of its value, it might be tempting to give your portfolio a dramatically more conservative profile with the expectation that things could get a whole lot worse before they get better. It's true, they could, but it's also true that investors make some of their worst behavioural mistakes at times like these, upending their well-laid financial plans because they let their emotions get the better of them.

A better approach is to be systematic about reviewing your holdings, checking up on them each quarter at the most, and being focused about the changes you make. As you conduct your portfolio check-up at midyear 2012, here's where you should focus.

Step 1: Assess Asset Allocation
It's natural to begin a portfolio review by cracking open your accounts and focusing on which of your investments has gained or lost the most. But rather than starting at the micro level—individual holdings—begin your review by assessing your total portfolio's allocation across the major asset classes: UK and international stocks, bonds and cash. The X-Ray function within Morningstar's Portfolio Manager tool can help you get a read on your portfolio's total positioning, which you can then compare with your targets. (Don't have targets for your asset allocation? Morningstar’s Asset Allocator tool can provide a good starting point.)

Given that stocks slumped in the second quarter and are also negative on a one-year basis, while bonds have fared well, your stock holdings might be below where you intended them to be. Pay special attention to your portfolio's international-equity holdings: If you haven't rebalanced for a while, your portfolio might have a significant home-country bias. Eurozone market woes won't resolve themselves overnight, to be sure, but I think it's sensible to retain a globally diversified portfolio because there won't be alarm bells going off when it's time to head back overseas. Because rebalancing might carry tax and transaction costs, I'd advise restraint before moving things around; look for your current allocations to diverge at least 5 percentage points from your targets before you rebalance, and more like 10 percentage points if you're a hands-off investor.

Step 2: Troubleshoot Sizable (and Unintended) Bets
Once you've conducted a review of your total portfolio's asset allocation, your next step is to review your allocations within those asset classes. Morningstar's X-Ray function can help, showing you your portfolio's allocations by region, sector and across the Morningstar Style Box.

Your portfolio needn’t be a clone of the FTSE 100, but be on the lookout for big bets in areas that might have got a little ahead of themselves. As Morningstar vice president of global equity and credit research Heather Brilliant pointed out in this article, the yield-starved environment has pushed many investors into income-producing stocks such as REITs, utilities and communication-services firms. As a result, some of these areas look expensive to our analyst team.

On the fixed-income side, I'd caution against devoting too much of a portfolio to non-core fixed-income assets, as I argued in this article; despite the siren song of higher yields, categories like emerging-markets bonds and junk bonds are supporting-player holdings at best, particularly for retirees who are counterbalancing equity holdings. At the same time, Morningstar senior credit analyst Dave Sekera cautions about taking on too much interest-rate sensitivity at this juncture, even though long-term bonds were a rare bright spot during the second quarter. If that sounds milque-toasty, that's about right; this doesn't feel like a great time to be taking big risks with a fixed-income portfolio.

Step 3: Check Liquid Reserves
Financial planners often talk about the importance of having liquid reserves on hand: that three- to six-month emergency fund if you're working, and one to two years' worth of cash if you're retired. That's as true as it ever was, but holding well in excess of those thresholds carries an opportunity cost. If your cash exceeds those parameters, you could consider building a two-part emergency fund, consisting of true cash plus a high-quality short-term bond fund. Alternatively, you could explore outside-the-box investments that promise safety and a higher long-term return than cash; reducing your interest-rate payments by paying off part of your mortgage, for example. 

Step 4: Bargain-Hunt, if You're so Inclined
If you're holding cash because your aim is to deploy it into stocks when they get beaten down, you might be encouraged to know that Morningstar's equity analysts think stocks look cheaper than they did three months ago, when most investors were feeling a lot more euphoric about the market. Though Europe's woes could drag on for several years, many UK businesses derive only a small share of their returns from eurozone exports. Our equity analysts therefore think that some wide-moat UK companies are the equivalent of babies thrown out with the bathwater. In addition, even though slowing global growth remains a concern, our equity analyst team thinks that both the energy and basic materials sectors look relatively cheap currently.

Step 5: Assess Your Savings Rate
Who hasn't rushed in an ISA contribution before the tax-year deadline? Although it's better than missing the deadline altogether, contributing to an ISA at the last minute and in one fell swoop deprives you of the chance to obtain a range of purchasing prices for your holdings—some higher, but some lower, as well. It also feels more painful from a wallet standpoint; if it turns out you owe a big tax bill around the same time you need to hit the ISA deadline, you might be inclined to blow off the contribution altogether.

Thus, a better strategy is to dribble your money into your ISA month by month until you hit the maximum contribution amount for the year—£11,280 in the 2012-2013 tax year. In a similar vein, check to see how much you've contributed to your company or personal pension plans to date. If you have the wherewithal to fund your plan to the limit, it's a good idea to set the pace right now rather than having to jack up your contributions in 2012's waning days.

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About Author Christine Benz

Christine Benz  is director of personal finance at Morningstar and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances.