(PUB) Investing 2015

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17 Morningstar FundInvestor February 2015
ultra-low-cost index products, that’s less of a selling
point for 401(k)s than it once was.
Do: Take the Best and Leave the Rest
Holding assets in multiple silos—401 (k)s, IRAs, 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.
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