Congratulations, you’re halfway done! The next step is to see how well your portfolio fits the risk profile and objective(s) you identified in the previous section. You also need to examine each of your investments and other assets individually to see whether each one is providing you with a competitive return relative to its peers.
If you're comfortable with finances, you can analyze your holdings on your own. A professional can speed the process and use tools you may not have, such as knowing how to quantify the volatility of your portfolio. The information listed in the previous section will provide at least a cursory idea of how well your current portfolio fits your profile – risk tolerance, for example – and objectives. To give you an idea of how this works, let’s look at a hypothetical scenario:
Wendy is 42 years old and works full time in marketing. She moved around from one job to another in years past, but is making good money in her current position and plans to stay there for the foreseeable future. She has a moderate risk tolerance and plans to work until age 67. She has accumulated the following assets since she graduated from college:
– Whole life insurance policy, $100,000 face value, $11,000 cash value;
– 300 shares of Sprint, purchased for her as a college graduation gift and held in a retail brokerage account;
– $10,000 in her employer’s 401(k) plan with a 3% matching contribution (she contributes 7% of her $50,000 salary), invested in an aggressive growth fund;
– $20,000 IRA rollover at a full-service broker, invested in a utility stock fund;
– $15,000 contributory Roth IRA at her bank, invested in a growth and income fund;
– $10,000 in a money-market fund (her emergency fund); and
– $40,000 of home equity, remaining balance on mortgage of $70,000, which will be paid off in 18 years.
Take the list of your investments and assets that you made in the previous section and make a spreadsheet, with a row for each asset.
Your Money, Your Profile: How Good a Match?
Next, put your investment profile in columns across the top: your risk tolerance (low, medium, high), time horizon (in years) and objective(s) whether growth, income, capital preservation or tax reduction. Then working from row to row, see how well each fund or asset fits your profile and objective(s).
Wendy appears to be reasonably on track. Because of her age, her primary investment objective at this point should still be growth, and her portfolio seems to reflect that for the most part. She has an adequate emergency fund, and her home equity is increasing as it should be. The mutual funds in her two IRA accounts seem to be a bit conservative for her at this point, since since she is a good 22 years from retirement. But if she continues to contribute $3,500 annually to the aggressive growth fund in her 401(k), with her employer's matching contribution of $1,500, it will become her main holding in just a few years.
By 25 years from now, when Wendy will be retired, the 401(k) could be worth more than $380,000 if it grows at an average annual rate of 10%. Meanwhile, if her utility stock fund and her growth and income fund grow at a 6% rate over that time, they will collectively be worth about $150,000. Her house should also be paid off by then. When she stops working, she may want to look at rolling over her retirement plan into a fixed or indexed annuity that can pay her a guaranteed income stream for life.
Of course, your risk tolerance and time horizon will likely differ from Wendy’s. If you were in her shoes, you might not feel comfortable having that much of your retirement money invested in an aggressive mutual fund and could choose more moderate alternatives. Just remember that you need to have at least the majority of your retirement money growing faster than inflation over time, so that your purchasing power is increasing. Wendy also has more conservative funds, her home equity, the cash value in her insurance policy and her emergency fund, so she is pretty well covered.
If your holdings don't match your profile and goals – you have moderate to high risk tolerance and are looking for growth, but your funds are mostly conservative, for example – the spreadsheet will make the mismatch obvious and show you what you might want to change.
But Is It a Good Growth Fund?
Now it's time to examine each of your holdings individually. How well is each of them doing?
Wendy would be wise to get a fact sheet on each of her mutual funds from Morningstar or a similar service that will provide unbiased commentary by third-party analysts on each fund’s performance, as well as a breakdown of historical performance, fees and expenses, and how the funds compare to their peers.
She is wise to hold her stock outside of a retirement account so that she can get long-term capital gains treatment on the sale whenever she decides to liquidate it. If she reinvests the dividends now, she can have another income source when she retires.
She should also look at how her funds are structured. Let's say that her growth fund is housed inside a variable annuity contract inside her 401(k) retirement plan, rather than being a stand-alone fund. The variable-annuity structure could reduce her returns over time, as variable annuities come with layers of fees and expenses. If she wants to really let her money grow, she would be wise to invest directly in a growth fund that is not part of a variable contract if that is available in her plan.
You need to give the same level of scrutiny to each asset on your spreadsheet.
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