Are You Taking on Too Much Risk in Your Portfolio?

Key Takeaways

• For midcareer accumulators, you want to be on the lookout for big style bets within your equity allocation. Between 5% and 10% in a single holding gets to be a lot.
• Holding three to six months’ worth of living expenses in liquid reserves is a good target for many people in their midcareer, but for a high-income earner, they should target a higher liquid reserve buffer.
• For people who are approaching retirement, target-date funds are a good benchmark to gauge whether you are in the right ballpark with your retirement assets.
• For retired people planning for liquid reserves, the Bucket approach can help with time-segmenting your portfolio.
• Investors of all life stages should be doing a cost audit of their portfolios to make sure that they aren’t overpaying.

Margaret Giles: Hi, I’m Margaret Giles from Morningstar. With volatility rattling the stock market, Morningstar’s Christine Benz thinks it’s a good time to conduct a risk audit of your portfolio. She’s here to discuss how to do just that. Christine, thanks for being here.

Christine Benz: Margaret, great to see you.

Portfolio Risks for Midcareer Accumulators During Market Volatility

Giles: So you think the types of risks that people should be looking out for really depends on their life stage. So let’s start with the people who are more than 10 years from retirement, so early or midcareer accumulators. What should they be looking for in their portfolios?

Benz: So people at this life stage often have a heavy weighting in stocks, which is fine, especially for those people in their 20s, 30s, 40s. That’s what they should have. But I think they want to be on the lookout for big style bets within that equity allocation. A really common one today is major concentration in the large-cap growth square of the style box. Of course, the US market is pretty concentrated in that large-cap growth square, but you want some diversification across the style box. You want to hold value stocks. You want to hold mid-cap and smaller stocks. And then you want to also be on the lookout for home-country bias, even though the path of least resistance for investors has been to just let their US equity holdings ride, we have seen a little bit of a reversal of that recently. Non-US stocks have been coming on strong. So for people who are looking for a benchmark on that front. If you look at the global market capitalization today, it’s about 60% US, 40% non-US. I think that’s a great sort of benchmark for people at that life stage. And the nice thing about adding to non-US exposure is that it also helps address that large-cap growth concentration. So you get a nice twofer by investigating your portfolio’s geographic exposures.

How Much Company Stock Is Too Much?

Giles: So you mentioned that concentration risk and that accumulators should be on the lookout. How much is too much to have in a single holding?

Benz: Well, I would say like 5% to 10% in a single holding gets to be a lot. And you want to do a little bit of investigation, especially if you are someone who uses individual stocks, as well as mutual funds or index funds and ETFs. Sometimes when I look at actual people’s portfolios, what I see is the stock positions often very much duplicate what is in the fund holding, so people have more concentration than they might have expected. And then another big culprit for concentration risk is that employer stock. Many people are incentivized in employer stock or encouraged to purchase their employer stock, and you just want to be careful. That can be a big source of concentration risk, and you just have to remember that your financial wherewithal is very much riding on that paycheck, and you don’t want to double down on that by investing too heavily in your company stock.

Liquid Reserve Buffers for Midcareer Accumulators

Giles: That’s helpful to think about. So this is also a good time to check up on liquid reserves. And if I’m still working and I’m not close to retirement, how much should I be holding in liquid reserves on an ongoing basis?

Benz: It’s an important point, Margaret, and I would say the three to six months’ worth of living expenses is a good target for many people. But in a lot of situations, you have someone who is a sole earner, maybe a high-income earner. For that person, I would probably target a higher liquid reserve buffer, maybe more like a year’s worth of anticipated spending. And the key is that you’re protecting yourself certainly against unanticipated expenses with your house, car, pet, whatever, as well as unanticipated job loss. And another kind of related tangent on this front, Margaret, is that younger people aren’t saving exclusively for retirement, typically. They also have shorter- and intermediate-term goals. So even if you’re a younger person, you would want to make sure to have those near-term spending needs or intermediate-term spending needs in something a bit safer than stock. So, if your time horizon for that pot of money, or for that segment of your portfolio, is fewer than, say, five years, even 10 years, you would want to have the money out of the stock market. You would want to have it in some combination of cash and short- and intermediate-term bonds.

Giles: Right. I feel like that’s often overlooked, those shorter time horizons.

Benz: People think I’m young and so my whole portfolio should look like I’m young, too. Not necessarily.

Portfolio Risks for Investors Approaching Retirement During Market Volatility

Giles: Exactly. So let’s discuss people who are approaching retirement. How should they assess their portfolio’s asset allocation with respect to risk?

Benz: Well, here I think target-date funds are a good, quick and dirty benchmark to gauge whether you are in the right ballpark with your retirement assets. So if you look at a target retirement fund for someone retiring in 2040, so roughly 15 years from now, it’s about 75% stocks today. Again, globally diversified, but it does start to build out those fixed-income holdings. And one statistic that really looms large in my mind is that the average retirement age in the US is, like, 62 today. So some of those retirements are early and happy, and people hit their number ahead of time. But some of them are situations where someone might rather work if they could. And the idea of building your buffer assets, your safer assets as you age, is just that you can’t perfectly predict the future. You may get knocked out of work due to health considerations, layoffs, whatever the case might be earlier than you expected. So the idea is, as you move through your 50s, certainly into your early 60s, you want to try to enlarge that position in safer assets because you want something to draw from in those early years of retirement if they happen to coincide with a bad stock market.

How Much Should Retirees Keep in Safe Assets?

Giles: So, you’re also a believer in retired people holding liquid reserves. So how much is enough for them?

Benz: Yeah, this is the Bucket approach that I often talk about, where you’re kind of time-segmenting your portfolio. Here, I like one to two years’ worth of portfolio spending in safe assets. So I’m doing a little bit of math here. Where I’m looking at my total spending, subtracting out what I’m getting from Social Security or a pension, and then the amount that’s left over is my portfolio spending. I’m multiplying that by whatever number of years seems like a safe buffer. So I think five at a minimum, 10 at sort of a maximum would be the amount that I would want to have in that combination of liquid assets, as well as intermediate- and short-term bonds. So one to two years in liquid assets, I think, is a good sort of target amount for many retirees.

How to Do a Cost Audit During Market Volatility

Giles: So to wrap up here, you think investors of all life stages should be doing a cost audit. What should they be looking for?

Benz: Right. Absolutely. Look at your holdings. Make sure that you aren’t overpaying. Certainly, using index funds and ETFs are a quick way to bring your costs down. When we look at fixed-income investments, fixed-income funds, what we see is a pretty tidy correlation between risk-taking and costs. So the high-cost fund that is hobbled with those high expenses is going to have to take extra risks simply to be competitive. So, certainly, if you have safer holdings in your portfolio, that’s an area where you absolutely want to cheap out to avoid that extra risk taking to compensate for those higher expenses. So start with fund expenses. It’s very easy to find how much you’re paying. Also look at tax costs. And we’ve talked a lot about tax costs over the years. Just make sure that you are paying attention to asset location, which types of assets you’re holding and which types of silos. Ideally, if you have taxable accounts where you’re not getting that tax break, you want to make sure that you aren’t holding tax-inefficient funds. So you want to make sure that you don’t have things that are kicking off a lot of income or big capital gains distributions. You want to try to minimize them within those taxable accounts.

And finally, look at what you’re paying for financial advice. I’m the first person to say that paying money for financial advice can be money well spent, but you want to make sure that you are getting good value for your money. So, certainly, if anyone is offering you investment advice, they should also be giving you advice about the totality of your plan. It shouldn’t just stop with your portfolio. So do a little bit of a back-of-the-envelope look at how much you’re paying in dollars and cents for that financial advice, and just make sure that you perceive it to be a good value for that outlay.

Giles: All right. It’s helpful to have those key areas to look out for, both in terms of cost and risk. Christine, thanks for taking the time.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch Are You Ready for Tax Day? Here’s What You Need to Know Before You File for more from Christine Benz and Margaret Giles.