(PUB) Investing 2015

February 2 015

Morningstar FundInvestor

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ultra-low-cost index products, that’s less of a selling point for 401 (k)s than it once was.

Do: Use Morningstar Analyst Ratings as a First Cut

If you have multiple holdings fulfilling the same role within your portfolio and are contemplating some cuts, it’s valuable to conduct a head-to-head compari- son. One of the quickest ways to do so is to consult Morningstar: Check a stock’s Morningstar Rating and a fund’s Morningstar Analyst Rating. These ratings are designed to provide a forward-looking assess- ment of a security’s prospects. Of course, you may have good reason to hang on to securities that don’t rate well: For example, you may have a very low cost basis in that 2 -star stock you’re holding in your taxable account, or your Neutral-rated small-cap fund may be the sole small-cap option in your 401 (k). But the ratings provide a sensible starting point in the process. Don’t: Focus Exclusively on Trailing Returns If you find duplicative holdings and are conducting your own “cage match” of two securities that play in a similar space, be careful not to focus too much on trailing returns. Despite recent volatility, the market has rewarded risk-taking since it began to recover in early 2009 . By focusing disproportionately on invest- ments with happy-looking trailing returns—especially over the past three- and five-year periods—investors may inadvertently tilt their portfolios toward higer- risk, higher-volatility investments. To help avoid that trap, make sure your due diligence encompasses an assessment of each investment’s risk profile. Eyeballing returns in the year 2008 is a good first step; you can also take a look at Morning- star’s upside/downside capture ratios for funds to see what kind of animal you’re dealing with. Morning- star’s Analyst Reports also aim to address the poten- tial risks that accompany each investment. And if you’re looking for a data point with the greatest predictive power for mutual fund performance, a fund’s expense ratio is the best way to stack the deck in your favor. You can’t go too far wrong by concen- trating your holdings in the lowest-cost investments in your choice set. K Contact Christine Benz at christine.benz@morningstar.com

Do: Take the Best and Leave the Rest Holding assets in multiple silos— 401 (k)s, IRA s, and taxable accounts—is all but inevitable for most investors, compounding the potential for portfolio sprawl. And you can multiply that problem by 2 if you’re part of a married couple, with each partner holding several distinct accounts. Many investors manage each of these subportfolios as well-diversi- fied portfolios unto themselves, necessitating expo- sure to U.S. and foreign stocks as well as bonds. However, you can reduce the number of holdings in your portfolio and ensure that each is best of breed by thinking of all of your retirement accounts as a unified whole. That’s because it’s the total portfolio’s asset allocation that matters, not the allocations of the constituent portfolios. For example, if your 401 (k) plan has terrific equity index funds but lacks solid bond options, you can load up on equities in the 401 (k) and compensate by holding more bonds in your IRA . Morningstar.com users can use the Combine tool—in the dropdown menu under Create in Portfolio Manager—to view the total asset allocation of their portfolios, even if they have stored their subportfolios separately. Don’t: Take Consolidation Too Far Even as accumulators can get away with the type of streamlining I just discussed, intra-account diver- sification becomes more valuable if retirement is close at hand. Because you want to retain the flexibility to pull assets from any of your accounts during retirement—Roth, traditional, or taxable—you may have good reason to hold both more- and less- liquid asset types within each of your accounts. That way, you can be flexible about where you go for withdrawals in a given year during retirement. In a high-tax year, for example, you might like to take a tax-free withdrawal from your Roth IRA rather than paying ordinary income tax on a withdrawal from your 401 (k). To account for potential withdrawals from the Roth, it may not make sense for that account to be 100% equity; you may also want to hold some safer securities, such as bonds and cash, too.