Christine Benz’s Year-End 6-Step Portfolio Checkup

By Morningstar
December 30, 2014 Updated: December 30, 2014

Video Transcript

Christine Benz: Hi, I’m Christine Benz for Welcome to a special video session about how to conduct a year-end review of your portfolio. It’s valuable to conduct such a checkup at least once a year to make sure that your portfolio is positioned exactly as you want it to be. In this session, I’ll discuss the key factors to focus on as you conduct your own review.

Before we get into the nuts and bolts of checking up on your portfolio, I wanted to share with you what I consider some best practices in the realm of portfolio checkups. The first point I would make is that less is more when it comes to this. So, for most investors, a quarterly, semiannually, or perhaps just an annual portfolio checkup is plenty. Any more than that, you risk tinkering around in your portfolio and making changes that, in hindsight, appear to be ill-advised.

The next key thing to keep in mind as you conduct your own portfolio review is to keep it targeted. And to do that, I’d recommend that you use a checklist of factors that you’ll focus on. That way, you cannot be distracted by some of the noise that may be around your portfolio right now.

The next thing I would emphasize is that it’s valuable to progress from the most important parts of the portfolio checkup to the least important parts. That way, if you get distracted or you don’t have time to conduct a full review, you will know that you’ve at least looked at some of the basic factors.

Another key thing I would say is that it’s valuable to focus on the fundamentals of your portfolio. So, rather than focusing specifically on performance and getting hung up on why a fund, for example, has underperformed or outperformed its category average, you want to instead home in on the fundamentals of your investments. So, if you have individual stocks in your portfolio, you want to pay attention to their profitability trends, their valuations. If you have funds, you want to focus on factors like manager changes and strategy changes. Those things will help guide the real changes that you will need to make in your portfolio review process.

And finally, if you determine that you need to make changes to your portfolio, it’s valuable to take tax and transaction costs into account. That’s particularly valuable right now. If you’re rebalancing your portfolio or shifting assets from parts of your portfolio that have performed really well, and you’re doing so within your taxable accounts, there’s a good chance that you will incur some tax costs to make those changes. So, it’s important to take into account both those tax costs and any transaction costs that you’ll pay to enact changes in your portfolio.

So, I want to run through the steps that I would urge each of you to take when you conduct your own portfolio-review checkup. The first is what I call kind of a wellness checkup on your portfolio. See how you’re doing toward your plan. The steps you’ll take here will depend on where your life stage is. So, if you’re in accumulation mode, you’ll want to take different steps than the person who has already retired.

The next step–and this is where’s tools can really come in handy–is to think about your portfolio’s current positioning. Using our X-Ray tool, you can get a good sense of your portfolio’s asset allocation, its style exposures, and other factors. I’ll talk about how to get the most out of that tool.

The next step is to look at your liquid reserves. This is important whether you are retired or still working. I’ll also talk about how to review individual holdings, and you’ll want to spend some time there. Those of you who are Premium users of can certainly use our analyst research to get the highlights of what’s going on with your stocks, funds, and ETFs.

I’ll also talk about troubleshooting some current risk factors–some things that are specific to the environment here in December 2014. I’ll share three specific risk factors that you’ll want to focus on as you review your portfolio at this year-end.

And finally, I’ll talk about how to make any changes, how to look at your portfolio with an eye toward reducing the drag of taxes. I’ll share some specific tips for doing that in the course of this presentation.

But first, let’s get right into the wellness-check part of the portfolio checkup. If you’re in accumulation mode, there are a few key factors that you want to keep an eye on. One is just to do a quick-and-dirty test of whether you’re actually saving enough. In the past, some people may have heard that saving 10% of their salaries was plenty, but I think a higher savings rate makes sense for most accumulators at this point–15% or even 20% or more, if you’re a higher-income earner. Those are good benchmarks to think about when you look back on your savings rate over the past year.

Fidelity has also released some benchmarks that can help you take a look at whether your current nest egg is on track with where it should be, given your life stage. So, if you’re a 35-year-old, you’d would want to have at least one times your current salary set aside; if you’re 45, three times current salary; if you are 55, at least five times current salary. Again, these are just some quick-and-dirty benchmarks, but some ways to see whether, in fact, you’re on the right track with your current savings program.

As 2014 winds down, it’s also important to see if you are on track to maximizing your 401(k) contribution or your 403(b) or 457 contributions for the year. For 2014, the contribution limits are $17,500 and $23,000 for folks over 50. We will be seeing a little bump up in those contribution limits for 2015. So, for folks under 50, the contribution limit for 401(k)s, 403(b)s, and 457s will be going up to $18,000 and a full $24,000 for people over 50. It’s important to remember that those contribution limits are the same whether you’re making Roth or Traditional 401(k) contributions. So, if you’re setting up your contribution rates for 2015 and are in a position to max out your contributions, see if you can hit those thresholds.

Another important thing to note is that if you are turning 50 in 2015, you can begin contributing at a rate that puts you on track to make catch-up contributions starting on Jan. 1 of that year. You don’t need to wait until your birthday. You actually have until April 15 to make IRA contributions, but it’s valuable to think about getting that money into the market as soon as you possibly can. So, for 2015, the contribution limits for IRAs, whether Traditional or Roth, are staying the same as they were in 2014.

So, for people under 50, they can contribute $5,500 to an IRA; for folks over 50, they can do $6,500 to an IRA for the 2014 and 2015 tax years. If you’re in accumulation mode, it can also be helpful to use some online tools to gauge the viability of your current retirement-savings program. A couple of tools that I often recommend are T. Rowe Price’s Retirement Income Calculator and Fidelity’s Retirement Quick Check. The T. Rowe tool is more comprehensive. It will require that you enter a little more information about yourself and your portfolio plan. Fidelity’s tool is a little more quick and dirty. It will help you get in the right ballpark in terms of your retirement-savings program.

Whatever tool you use, though, I would say that you would want it to incorporate the following key factors. You would obviously want it to be incorporating the potential rate of inflation over time and the bite that that can take out of your nest egg–both as you’re accumulating and as you begin spending your money. You will also want to make sure that it is incorporating reasonable return expectations for various asset classes. So, if you see return expectations that the calculator is embedding that are, say, 10% for equities, in my mind that’s probably unrealistic. Probably, you want to look for equity return projections that are more in the realm of 6% or 7%.

You also want to make sure that it’s taking taxes into account. That’s one reason I like the T. Rowe tool, because it does take into account where you might hold various types of assets. It takes into account both the benefits that you get when you are holding your assets there and your money is accumulating on a tax-deferred or tax-free basis, but it also takes into account the haircut that you take when you begin withdrawing your money.

And finally, it’s also wise to look for a tool that incorporates the role of other income sources that you will be bringing into your retirement. So, for many of us, that will be Social Security. For some lucky folks, that will also be pensions. But the idea is that any tool you’re using should also be factoring in those nonportfolio sources of retirement income when gauging the viability of your plan.

If you’re retired or almost retired, you want to focus on a different set of variables. Specifically, you’ll want to look at your spending rate in the past year and make sure that it passes the sniff test of sustainability. There are lots of different ways to think about spending rates in retirement, but one rule that retirees may have heard about is the 4% rule. And what that means is that, in year one of your retirement, you’re going to take 4% of your portfolio’s balance and then you’ll take that dollar amount and inflation-adjust it in subsequent years.

So, using an example with the 4% rule, assuming an $800,000 portfolio, that year-one withdrawal would be $32,000, and then we just nudge it up a little bit to account for a 3% inflation rate in year two. That 4% rule has been generally pretty well stress-tested in a variety of market environments, and a lot of practitioners agree that it is a reasonable starting point when retirees are thinking about their own spending rates. But it’s important to really bear in mind some of the assumptions that underpin the 4% rule. So specifically, the 4% rule assumed a 30-year time horizon, and it also assumed a 60% equity/40% bond asset allocation. So, if your own portfolio’s asset allocation doesn’t resemble those parameters, you’d want to make adjustments accordingly.

So, for example, if you have a much shorter time horizon than 30 years, you could arguably get away with a higher spending rate than the 4% rule. Alternatively, if you have a much more conservative asset allocation, you’d want to think about a more modest spending rate than 4%, perhaps 3% would be a more realistic starting point.

The next step in the portfolio-review process is to spend some time reviewing your portfolio’s positioning, and here’s where Morningstar’s X-Ray tool can be invaluable. You can access X-Ray in a few different ways. If you are a free user of the site, you can use Morningstar’s Instant X-Ray tool. Or if you’re a Premium user and you have a portfolio saved on the site, you can use the X-Ray function within the Portfolio Manager tool.

No matter how you gain access to X-Ray, you’ll see a screen that looks something like this. There’s a lot of data here, but my advice is to focus on the pie chart in the upper left-hand corner. This depicts your portfolio’s exposure to the major asset classes–stocks, both U.S. and foreign; bonds; cash; and other asset classes. This is going to be the biggest determinant of your portfolio’s performance over time. So, you want to pay the most attention to it, and you want to spend time looking at this allocation–your real allocation according to X-Ray–and comparing it to whatever target you have set up for your portfolio plan.

So, when you think about whether it’s time to actually make changes if you see big divergences in your X-Ray versus your portfolio plan, I would [suggest you] focus on divergences of more than five or 10 percentage points. If you see divergences higher than that, it’s probably time to get in there and think about doing some rebalancing of your portfolio. Vanguard did some great research that looked specifically at how often you should rebalance, and those were the intervals that they generally arrived at–that if you see divergences of five percentage points, it probably makes sense to correct them.

Many portfolios following this great equity-market runup that we’ve had for more than five years running now are probably heavier on stocks than many investors intended them to be. So, a portfolio that was 50% stock/50% bond five years ago would now be about two thirds equity at this point. It is well overdue for rebalancing if you’ve been a very hands-off investor. So, focus on that asset-allocation decision. Again, it is going to be the biggest determinant of how your portfolio behaves.

So, if you have gone through this process of comparing your portfolio’s asset allocation to your targets and found out that, in fact, you’re light on stocks, there are a couple of key things to keep in mind. The first is that even as the market isn’t egregiously overvalued currently, it’s not especially cheap based on our analysts’ price/fair values for all of the companies in their coverage universe. The typical company we cover is trading right in line with its analyst’s estimate of fair value currently. It doesn’t mean stocks are expensive, but nor are there a lot of bargains to be had.

So, I think for many investors who determine that they’re light on stocks, a dollar-cost averaging program will probably make sense, whereby you move the money into the market in fixed sums at regular intervals, perhaps monthly. That can be a great thing to think about.

It’s also valuable to think about whether you have value-oriented funds in your portfolio. In this kind of market environment where stocks aren’t particularly cheap, but there may be bargains here and there, it may be helpful to know that you have a good bargain-hunting manager working on your behalf. You can also look to Morningstar’s highly rated stocks for ideas. One of the key things that we ask our equity analysts to do is to put these fair values on the companies they cover. So, our analysts are keenly attuned to valuations when they make recommendations. They don’t want to recommend stocks that are too expensive given what they expect their future earnings to be. So, you can look to Morningstar’s highly rated stocks as a starting point for further research.

Another idea is to perhaps hold a little bit of extra cash. I think it’s safe to say that there will probably be more volatility to come in 2015, so you may benefit from having a little bit of dry powder set aside.

On this slide, I’ve just compiled a short list of some value-leaning funds that we like. For those of you who have been longtime Morningstar readers, you know that a lot of these funds have been our favorites for many years. I’ve got a sampling of companies that cut across asset classes, and I’ve also got a few international funds on this list as well. But in general, the commonality among these funds is that they are all Gold- or Silver-rated, so they’re among our top-rated funds, and they all have at least some sort of a value orientation. Some of them land in Morningstar’s blend style box, but generally speaking, they tilt toward value. So, they are run by managers or they’re index funds that do emphasize stocks that might be relatively inexpensive at this point in time.

On this next slide, I’ve highlighted a few companies that passed three key hurdles. First, they have 4 stars, meaning that our analysts think that they’re relatively inexpensive; second, they have wide moats, meaning that our analysts think that they have sustainable competitive advantages; and finally, they have what we call low uncertainty ratings. And what that means is that the analyst feels that he or she can forecast the company’s future earnings with a pretty good degree of accuracy. So, this is just a short list of companies that are worthy of perhaps further research. One thing you will notice when you look on this list is that there is a pretty heavy emphasis on the energy sector, and that’s in part because our analysts think that energy stocks are pretty inexpensive at this point in time. But there are a handful of other sectors represented here as well. We’ve got a few health-care names as well as some consumer names. Again, just a short list of reasonably valued companies. If you’re thinking about adding stocks to your portfolio and you are an individual stock investor, these are a few different ideas to consider.

If you’ve gone through the process of comparing your asset allocation to your targets and found that you’re light on bonds, there are a few things to keep in mind. First, if you’re adding bond exposure, it makes sense to keep it pretty plain-vanilla and core rather than trying to guess the direction of interest rates. Long-duration bonds had a great rally in 2014, but it’s an open question and quite debatable whether they’ll in fact repeat that performance in 2015. So, my advice is that if you’re adding fixed-income exposure, keep it core, limit your interest-rate sensitivity to short- or moderate-term, intermediate-term bonds, and also keep credit quality generally high.

High-yield bonds have had a little bit of a hiccup here in 2014’s fourth quarter; but for the core of your fixed-income exposure, if you want to add to the part of your portfolio that will behave differently from your equities, you want to add to high-quality bonds. At this juncture, I think it makes sense to add to a core, flexible fixed-income fund, perhaps an active funds like Metropolitan West Total Return Bond (MWTRX) or maybe Dodge & Cox Income (DODIX) or perhaps use an index fund like a total bond market tracker to keep your costs way, way down while giving you fairly well-diversified exposure to the bond market.

If you’re someone who is getting close to retirement, de-risking that portfolio is particularly important. So, you want to do that as soon as you possibly can. But I think if this describes you, if you’ve gone through the asset-allocation review and found that you’re notably light on bonds, you probably want to tiptoe into bonds very slowly over a period of time. So, my advice would be to de-risk immediately, move the money that you have earmarked for bonds into cash, and then slowly deploy that money into the bond market over the next year or two. The benefit of doing that dollar-cost averaging is that you will be able to obtain exposure to a variety of interest-rate climates. So, if interest rates climb, you won’t have put a lot of money into the market at what, in hindsight, could have been an inopportune time.

In addition to checking up on your asset-class exposure, it’s also valuable to check up on your sector and style exposure, your geographic exposure, how heavily weighted you are in U.S. markets versus foreign, and also whether you have any individual-stock overload your portfolio. Our Stock Intersection tool can help you see what your biggest positions are, and this can be a particularly big problem for those of you who have company stock. It’s easy to let those position sizes hog too much of your portfolio. The reason you don’t want to have too large of a position in company stock is that you have a lot of your economic wherewithal staked with your company; you don’t want too much of your portfolio staked with it as well.

On this next slide, I’ve included a few benchmarks for evaluating your portfolio’s style and market-cap exposures. On the left-hand side of the slide, I have the total U.S. market’s style exposure, which you can use as a benchmark for your own exposure. So, you can see that a total U.S. market index currently has about 75% of its assets in large-cap stocks, about 18% currently in mid-cap stocks, and about 9% currently in the small-cap row of the style box. Your portfolio’s positioning doesn’t have to mirror this exactly, but it’s still valuable to know where you have big divergences and make sure that you’re comfortable with any of those bets.

On the right-hand side of the screen, I’ve looked at the price/fair values for each of the squares of our Morningstar Style Box. So again, this is based on our analysts’ research, and you can see that right now our analysts think that the cheapest companies in their coverage universe land in that large-cap value square, whereas the growth side of the style box is relatively more expensive, with large-cap growth being the most expensive square of the style box currently. You can see that mid-caps, in particular, look the most expensive to our analysts currently, especially over there on the growth side of the style box.

On this next slide, I’ve got some benchmarks for evaluating your portfolio’s global allocations. So right now, thanks in part to the U.S. market’s strong performance relative to major foreign markets, the U.S. is now more than half of the globe’s market capitalization. Check your portfolio’s own exposure. Most U.S. investors don’t need roughly 50% foreign-stock exposure; but it’s true also that most U.S. investors have probably a little too much of a home-market bias.

So, for folks who are in early accumulation mode, it’s reasonable to have at least 30% or perhaps 40% of their portfolio’s equity exposure in foreign stocks; for folks who are getting closer to retirement, though, they would want to scale back on that foreign-stock exposure, in part, because you typically get big currency fluctuations that come along with your foreign-markets exposure.

That’s not something you want in your portfolio necessarily, as you get close to spending your money in retirement. So, think about your geographic distribution and also think about your emerging-markets exposure. So, here is simply the percentage of the global market cap that is in developed markets versus developing markets currently. So, developed markets are more than 90% of the global market cap; developing markets are just about 9% currently.

So, the next step in the portfolio-review process is to check your liquid reserves, and the benchmarks you want to use are a little bit different, depending on your life stage. So, if you’re someone who is still working, you want to think about having that emergency fund in place. And the standard rule of thumb here is to think about having three to six months’ worth of living expenses set aside in true cash instruments.

If you’re someone who is retired, I would set the bar a little higher in terms of liquid reserves. I have written a lot about the bucket strategy for retirement-portfolio planning. So, what I typically recommend is retirees keep about six months to two years’ worth of living expenses in true cash instruments. The idea is that if your bond portfolio or your stock portfolio is gyrating around, you know that your liquid reserves will tide you through some volatility in the longer-term pieces of your portfolio.

As you are calculating your liquid reserves, be careful not to use X-Ray for this part of the process. The key reason is that X-Ray takes into account the underlying cash exposures in your various mutual funds, which you won’t have access to as liquid reserves if you actually need to get the money out. You’d need to liquidate the whole position in order to gain access to the cash. So, hand-calculate your liquid reserves to get an accurate reflection of how much true cash you have on hand currently.

If you are retired and you need to refill your bucket one–if you’re using the bucket system for your retirement-portfolio planning–there are a few key ways to think about refilling that bucket one. The strategy that I always recommend is to see how far your dividend and income distributions go toward refilling bucket one. So, you could perhaps have that money that is coming out of your long-term holdings in the form of income and dividend distributions, have that directed directly into your cash account so that that account refills automatically on an ongoing basis. Then, if those income and dividend distributions are not sufficient to meet your living expenses or to refill that bucket one, you would want to think about rebalancing to further lift up your liquid reserves in bucket one. So, those are some things to think about if you are employing that bucket strategy and spending the cash in your bucket one; you periodically need to replenish it. Here are the key steps that I would take as you do so.

The next step in the review process is to review your individual holdings. And here’s the spot where Morningstar’s Premium service can really help you do the job very quickly. We ask our analysts to summarize all of the salient things going on with the funds they cover and the stocks they cover. So, you can use those tools; you can use the analyst reports to quickly get an overview of what’s going on with your holdings.

If you’re conducting your own due diligence and you are a fund investor, some of the key things to focus on, especially if you want to pay attention to where you might have yellow or red flags in your portfolio, would certainly be manager changes, strategy changes, and ratings changes. If a fund that you hold moved from Gold to perhaps Bronze or even Neutral, it’s worth digging in and finding out what’s going on.

You also want to pay attention to persistent underperformance of your fund holdings versus inexpensive index funds. You want to give your funds, if you have active funds in your portfolio, at least a few years–perhaps even several years–to prove themselves; but if they haven’t proven themselves over a full market cycle versus an inexpensive index fund, it’s perhaps time to think about swapping into a cheaper product. You also want to be mindful of any dramatically heavy sector or individual-stock bets that might be going on in your fund holdings. That’s not to say they shouldn’t be there. In fact, when I think of some of the most effective fund managers, they do employ big stock or sector bets; but you still need to be aware that those sorts of emphases can lead to extra volatility.

If you’re a stock investor, you want to consider a few different things as potential yellow or even red flags–things that you’d want to follow up on because they could be indicative of trouble at your holdings. So, certainly a very high price/fair value for companies that you hold or a low star rating, both of those things–and they will tend to work hand in hand–could be an indication of an overvalued stock. You also want to pay attention to the moat trend of the companies that you hold. So, if you had a company that had a wide moat in the past, but you’ve seen it’s gotten downgraded to a narrow or perhaps even a no-moat rating, that’s definitely a consideration that you should bear in mind as you review your portfolio.

The next step in the review process is to look at potential risk factors that could lurk within your portfolio. I would call your attention to a few key ones that pertain to the current market environment. The first is if you are adding to bonds or have bonds in your portfolio, you would want to think about risk factors that could lay ahead for the bond market. I will talk about a few ways to think about sizing up your fixed-income exposure.

The next risk factor to stay attuned to is inflation. I think investors have arguably grown a little bit complacent about inflation, certainly fund flows suggests that they have been. I will talk about why I think you need to stay attuned to inflation as a risk factor for your portfolio, especially if you’re retired.

And then the last risk factor that I would highlight is potential overvaluation in the dividend patch among dividend-paying stocks. We’ve seen very strong performance from this part of the market. Investors love dividend-paying stocks. I think they just want to be careful to make sure that they’re not overpaying for any dividend exposure that they’re adding to their portfolios right now.

So, let’s just take these one by one. Looking specifically at the risks that could lie ahead for bond investors, one risk that I think it’s important to stay attuned to is the amount of credit-quality risk in your bond portfolio. Investors have been retreating from high-yield or junk-bond funds. They’ve also been retreating from bank-loan funds, which is another generally lower-quality category. But one category that they’ve been buying pretty aggressively is the so-called non-traditional-bond fund group. We’ve seen some pretty strong asset flows into these fund types over the past few years.

One thing to know about the non-traditional-bond group is that even though it’s not labeled as lower quality, many funds in this group do have pretty low-quality credit profiles. So, if you’re buying such a fund, it’s important to understand how much low-quality exposure might be within that portfolio, and it’s also important to understand that arguably there is not the yield cushion there for low-quality bond investors that there has been historically.

So, when we look at the yield spread between high-yield bonds and Treasury bonds currently, it’s in the neighborhood of five percentage points. It’s come up a little bit over the past month or so, but it’s still very narrow relative to historic norms. If you think back to 2008, for example, spreads were in the double digits at that point. So, investors who were buying high yield at that point were really getting themselves a nice cushion to buy high yield. That’s not something that investors necessarily have today.

So, if you’re among the investors who are attracted to this non-traditional-bond category, it’s important to keep your eye on what types of exposures come along with that portfolio type. Janet Yellen, the Fed chair, has indicated that she and the rest of the Fed are concerned about investors perhaps chasing yield, perhaps adding to lower-quality bonds and not fully considering some of the risks that come along with these bond types.

At the other side of the spectrum, though, investors also need to be careful about taking too much interest-rate sensitivity in their bond portfolios. I have often talked about what’s called a duration stress test. I think this is a valuable stress test to run your own high-quality bond portfolio holdings through as you think about the risks that could lie in your bond portfolio. So, to conduct this stress test for each of your holdings, you really just need to come armed with a few different data points. The first is what’s called SEC yield, Securities and Exchange Commission yield; the second is what’s called duration. So, find those two numbers and what you’ll do is that you will subtract that SEC yield from duration, and the amount that you’re left over with is the amount that you’d expect that holding to lose in a one-year period in which interest rates trended up by one percentage point. So, that’s a big jump up in rates, but it’s potentially not unrealistic over the next several years.

So, run your holdings through this particular stress test. It’s not going to be useful if you have a holding that is not a high-quality bond holding. It will just tend to be a less useful metric; but definitely if you have high-quality fixed-income exposure, see how your funds do from the standpoint of the stress test.

So, here are just a couple of examples that you can use. Vanguard Total Bond Market Index (VBMFX) currently has a duration of about 5.6 years. Its yield is just under 2% currently. So, you can see in that one-year period if rates were to trend up by one percentage point, that investor in that index fund would have roughly a 3.7% loss. Again, this is a very rough gauge. You shouldn’t expect it to be a very precise gauge.

If you have a long-term bond index fund, you can see that you would be in for a lot more pain if in fact interest rates trended up. So, that particular portfolio currently has a duration of 14.4 years. Its SEC yield is just under 4% currently. So, that investor would see a much more significant loss in that rising rate period, a roughly 10% or 11% loss during that window of time if rates rose by one percentage point in that one-year period.

Another risk factor to bear in mind as you think about reviewing your portfolio right now is whether you have adequate insulation against inflation. One thing we see when we look at fund flows is that investors appear to be selling inflation hedges hand over fist. So, we’ve seen strong outflows from Treasury inflation-protected securities, funds that focus on these securities, and the reasons could be two-fold. One is that CPI has been pretty modest, so investors haven’t felt concerned about inflation, and the other thing is that a lot of core TIPS products are pretty interest-rate sensitive. So, investors may be selling them for one of those two reasons. They’re afraid of rising interest rates or perhaps they don’t care about inflation or perhaps both.

We’ve also seen pretty strong outflows from other investments that we often think of as being good inflation protectors–so, precious metals, equities, exchange-traded funds that buy gold bullion, commodities-tracking investments. They’ve all seen pretty strong redemptions over the past few years. The performance hasn’t been good, but it could also be an indication that investors aren’t paying due attention to the value of having inflation protection in their portfolios. It’s always valuable to add inflation protection before inflation actually materializes.

You don’t want to be running and adding to some of these hedges at the same time their prices are increasing. Just make sure that they’re in your portfolio as a long-term hedge, and that is particularly important if you are someone who is retired. The reason is that if you’re not able to earn cost-of-living increases from your paycheck, if you’re not getting a paycheck, you need to make sure that your portfolio distributions are somewhat inflation-protected. So, laying in some of these hedges is a way to add that insulation. One thing to note is that, even though inflation as a whole is fairly benign, we have been seeing food costs running higher than they have historically–and food costs tend to be a pretty big line item in many retiree households as well. So, it’s important to make sure that you do have those inflation hedges in your portfolio.

When we think about the investment types that offer the best long-term insulation against inflation, a few ideas are Treasury inflation-protected securities, which will tend to be your best long-term hedge and your most direct hedge against inflation. Stocks certainly are the asset class that has the highest potential to outrun inflation over time; so you’d want to make sure that your portfolio includes ample stock exposure, even if you’re someone who is already retired. And a few other, perhaps supplemental, inflation hedges include real estate commodities and gold. As standalone investments, they can all be pretty volatile, especially commodities and gold, so you would want to keep their total exposure as a percentage of your portfolio to less than 10%, ideally.

And finally, bank-loan investments or floating-rate funds: This is a category that investors have definitely been selling over the past year or so. They had been very popular in the year prior. I think this is a category, when you look at its historical performance, there’s been a pretty nice correlation with inflation. These funds tend to perform pretty well at a time when inflation is running hot. So, this is another category to consider as part of your fixed-income exposure.

Another potential risk factor to keep your eye on as you conduct your portfolio checkup is to look at the valuations of any dividend-paying stocks in your portfolio. And certainly, if you’re adding dividend-paying stocks in your portfolio, just make sure that you aren’t overpaying for them. One graph that I often like to look at on is our Market Fair Value Graph, and that simply aggregates all of the price/fair values for all of the companies in our coverage universe and looks at them as a group. What we see when we look at that number today is that the typical company we cover is right in line with our analysts’ estimate of its fair value. But when we look at some sectors that have historically been dividend-rich sectors, what we see is some slightly higher price/fair values for the average companies in those coverage universes.

So, in health care, for example, the typical company there is trading slightly above our analysts’ price/fair value. REITs are currently the most overvalued sector in aggregate–REITs, again, historically a pretty dividend-rich area. And utilities as well, even though they’ve come down a little bit recently, have been trading well above our analysts’ price/fair value, on average.

It’s also worth noting, though, that even as there may be some overpriced stocks in the dividend universe, there may also be some pockets of opportunity. So, on an earlier slide, I showed you some names that our analysts think are cheap and well-managed, well-run companies. When we look at the typical energy company within our coverage universe, we see a price/fair value that is well, well below 1.0. So, the typical energy company that we cover is trading at about three fourths of our analysts’ estimate of fair value. So, that may be a pocket of opportunity for dividend-focused investors going forward. That’s not to say they will turn around overnight, but it may be an area worthy of further research.

The final step in the review process is to see if you can take some steps to reduce your investment-related tax bill for 2014. The year 2014 was a pretty good one for stock market investors–and 2013 was even better–but that could translate into above-average investment-related tax bills for the 2014 tax year. For one thing, investors may be unloading highly appreciated positions if they’re doing rebalancing, and the other thing is that we saw some pretty hefty capital gains distributions coming from some actively managed mutual funds in the waning days of 2014. This was happening for a few different reasons. One is that we’ve seen a very strong rotation into exchange-traded funds and other index products out of actively managed funds, and that has forced some active fund managers to have to sell securities to pay off departing shareholders. So, that has been one of the triggers for above-average capital gains distributions.

Another factor in the mix is that those distributions, because some shareholders have been leaving, they’ve been having to get paid across a smaller shareholder base. So, that’s one reason that we did see pretty high capital gains distributions from a number of funds in December of 2014.

There are a couple of steps you can take, though, to reduce the tax pain that comes along with those capital gains. The easiest thing to do is to scout around and see if perhaps you have some losing positions in your portfolio. Recently, there were more than 6,000 companies in our database that had one-year losses of greater than 10%. So, if you’re an individual-stock investor, you may in fact have losing positions. If you’re a fund investor, it may be a little more difficult to unearth losing positions, but they may be there if you look around.

So, a couple of categories to look at would be commodities, energy, perhaps precious metals, perhaps Latin America equity–those could be a few categories, if you have them in your portfolio, where your positions are trading above your current purchase price. You may be able to harvest those losses. If you have those losses, you can use them to offset capital gains. If you have used your losses to offset all of your capital gains, you can then use those losses to actually offset ordinary income. So, it’s well worth looking within your portfolio to see whether perhaps you do have any tax losses.

It can also make sense if you are conducting rebalancing in your portfolio. A good way to keep your own capital gains down would be to make sure that you’re concentrating any rebalancing efforts within your tax-sheltered accounts. You won’t pay any tax costs to make those trades, whereas if you are rebalancing in your taxable accounts and you’re needing to sell winners, those will result in tax costs. That’s why we usually say to concentrate your rebalancing in your tax-sheltered accounts–see if you can move the needle there first before turning to your taxable accounts.

When you think about positioning your portfolio going forward with an eye toward limiting tax costs, you want to make sure that your taxable portfolio is as tax-efficient as it can possibly be. So, if you are an equity investor, a few different types of investments give you a greater level of control over your tax burden on an ongoing basis. If you have a taxable account and are holding stocks there, certainly individual stocks give you the most control over your capital gains realization. If you’re a fund investor, you would want to think about exchange-traded funds. If you’re holding equities, tax-managed funds–these are funds that are explicitly set up to minimize capital gains distributions–that would be another category, as well as broad-market index funds.

All of these investments, on an ongoing basis, tend to be pretty tax-friendly. They’re good picks for taxable accounts. If you have bonds in your taxable portfolio, depending on your tax bracket, municipal bonds may be the better bet. Use Morningstar’s Bond Calculator; the tax-equivalent yield function tab on that calculator will help you see if you’re a good candidate for municipal bonds versus taxable bonds in your taxable portfolio.

For all investors, I would urge you to use the specific share identification method when calculating your cost basis. This basically means that you can cherry-pick which specific lots of a given investment you’d like to sell at any given point in time. So, you can choose to sell the lot that’s most advantageous for you to sell at that particular time. It gives you the most control over your tax burden on an ongoing basis.

In addition to making sure your portfolio is as tax-friendly as it can be on a going-forward basis, you also want to take a look at other things you can do to reduce or 2014 tax bill. Certainly, if you’re over age 70 1/2 and required to take minimum distributions from Traditional IRAs and 401(k)s, you’ve got to take those by Dec. 31; otherwise, you’ll owe a big penalty. So, you want to make sure you take those on time.

It’s also worth considering, especially if you’re charitably inclined and you are taking those distributions, you might be able to benefit from what’s called a qualified charitable distribution. And what that means is that you simply send part of your required minimum distribution directly to the charity of your choice. The advantage of doing that, as opposed to taking the RMDs and later making the charitable contribution, is that the QCD–as it’s called–reduces your adjusted gross income. And that, in turn, can increase your eligibility for deductions and other credits that you may be able to take advantage of.

So generally speaking, this QCD is preferable to making the charitable donation later on. Certainly, people of all ages, whether retired or not, will want to look at making charitable contributions for the 2014 tax year; they can all deduct those contributions on their tax return. It’s also a good time to make sure that you are on track to making any 401(k), IRA, and health-savings account contributions. You actually have until April 15 to make the IRA and HSA contributions, but it’s a good idea to get the money into your account as soon as you possibly can so that it starts working on your behalf–because, presumably over time, the investments that you have in those accounts will go up. So, the sooner the money is in there, the sooner it can begin to compound.

It’s also a good idea to make sure that you are putting your 2015 contributions on autopilot. As we saw in an earlier slide, those contribution limits are going up a little bit for 401(k), 403(b), and 457 plans in 2015, so you want to make sure if you are in a position to fully fund those accounts, that you are spacing those contributions throughout the year. Putting those contributions on autopilot can be a great thing to do.

If you are someone who is saving for a college, it’s a great time to think about funding those 529 college-savings plans; that way, you can obtain the deduction on your state income tax that most states offer on their home state 529 plans at this point in time. So, it’s also a great idea to keep close tabs on your deductible expenses for 2014, especially if you are itemizing your deductions, such as health-care costs. Keep a folder of all of that information where you’re closely tracking what those deductible expenses have been.

And finally, another strategy that I’ve been hearing a lot about from our retired investors, in particular, is this idea of bunching deductions from year to year. So, in some years, retirees tell me that they itemize their deductions; in other years, they take the standard deduction. So, in those years when they know they’ll be itemizing, they kind of gang up those deductible expenses, especially those over which they exert some level of control. They try to get those all happening in the years in which they itemize.

So, there are many different things that you can do to help lower your tax bill for 2014. Here is just a short list of things to have on your radar as the tax year winds down. I have been through a lot of different factors today as I’ve talked about how to conduct a portfolio checkup. I hope that you will be able to implement a few of these as you look across your own portfolio plan.

Thank you for watching and best wishes for a happy and profitable 2015.

*Image of “investment portfolio art” via Shutterstock