A Quick Guide to Reviewing Your Holdings
Benchmarking performance and watching key metrics are essential to evaluating whether your retirement holdings are doing their job.
Investing Specialists
Note: This article is part of Morningstar's January 2015 5-Point Retirement Portfolio Checkup special report.
Whether your retirement portfolio consists of dozens of holdings or just a few, from time to time, it's a good idea to assess how each is performing and to take a look under the hood. That's why it's important to know which performance benchmarks and key metrics to use when sizing up each holding individually. In doing so, you should look at both past performance and forward-looking measures designed to provide guidance as to how the investment will perform moving forward. That way, you can determine whether things in your portfolio are humming along just fine, a few upgrades are in order, or wholesale changes need to be made.
Take the Long View on Past Performance
The metric that investors tend to focus on most, of course, is total return, a backward-looking measure. But reviewing a holding's total return versus its benchmark and peer group requires a dose of perspective. For one thing, it's important not to place too much emphasis on near-term results. If a fund you own has performed poorly of late, try to understand why. Perhaps the fund's manager has placed an outsized bet on a particular sector that has underperformed in the near term but is poised to rebound soon. Likewise, don't be lulled into overconfidence by near-term outperformance--today's outperforming investment often becomes tomorrow's underperformer.
Remember that you're investing for a retirement that may be years--if not decades--away, depending on your age. If you're more than 10 years from retirement, you have time to ride out the market's ups and downs. If you're closer to retirement, you may want to ratchet down the risk; but you'll still need to have a good sense of how your holdings may perform once you stop working. Whatever your retirement time frame, focus on your holdings' performance over the trailing five- and 10-year periods, but also pay attention to how they've reacted in different market environments. You could begin your analysis by focusing on 2008, when the financial meltdown sent stock prices plummeting and bond prices higher. But also look at 2013, when stocks posted strong gains while bonds languished.
Using Appropriate Metrics
Of course, your portfolio probably contains at least a few different asset types, meaning you'll need to pay attention to benchmarks and metrics that are most relevant to each type. For example, volatility and risk measures may be more important to you when it comes to your stock holdings, whereas interest-rate sensitivity probably matters more to you with regard to your bond holdings.
The following guide is designed to point you in the right direction when it comes to benchmarking the performance of various asset types and identifying other important metrics to watch. It's by no means a comprehensive list, but it's a good place to start. Metrics can be found on the investment's Quote page unless otherwise noted.
Individual Stocks
Key performance benchmarks
- Domestic large-cap stocks: S&P 500 Index
- Domestic small-cap stocks: Russell 2000 Index
Key forward-looking metrics
- Morningstar Rating for stocks: Represents a stock's current trading price relative to our analyst team's assessment of its fair value price. Stocks rated at 4 or 5 stars are trading meaningfully below their fair value estimates (meaning they appear to be underpriced), while those rated at 3 stars are fairly priced and those rated at 1 or 2 stars are trading above their fair value (meaning they appear to be overpriced).
- Morningstar Economic Moat Rating: Analyst assessment of whether the company has one or more sustainable competitive advantages, with ratings ranging from wide to narrow to none. Companies with economic moats tend to be better at sustaining profitability over time than those without them. For more on moat ratings, click here.
Key backward-looking metrics
- Revenue growth: The amount of money the company brings in year over year, and a good indication of whether it is growing and to what degree. You can find Revenue under the Key Ratios tab on stock pages on Morningstar.com.
- Operating Margin: A measure of company profitability. The wider the operating margin, the more the company makes on sales of its products or services. Found under the Key Ratios tab.
- Free Cash Flow: Another measure of company profitability, based on the firm's cash flow from operations minus its capital spending. Found under the Key Ratios tab.
Domestic-Stock Mutual Funds and ETFs
Key performance benchmarks
- See Individual Stocks section above.
Key forward-looking metrics
- Portfolio statistics: Found under the Portfolio tab, includes a breakdown of the fund's asset allocation, investment style, and market-cap and sector weightings.
- Expense ratio: Amount of the fund's total return siphoned off by the fund company to cover its expenses. The higher a fund's expense ratio, the greater its performance must be in order for it to keep pace with or outperform less expensive funds. This is particularly relevant with regard to actively managed funds, which tend to charge higher fees than their passively managed (index) counterparts.
Key backward-looking metrics
- Morningstar Rating for funds (star rating): Measure of a fund's risk-adjusted returns relative to its peer group over various time periods. For more on how this is calculated, click here.
- Morningstar Risk rating: Measure of a fund's rate of return relative to its downside volatility (risk) over a given time period as compared with that of its peers. The higher the rating, the worse the fund's return relative to the amount of risk it takes. Found under the Ratings & Risk tab on fund pages. For more on using this metric, click here.
- Standard Deviation: Volatility measure based on the degree to which fund returns have fluctuated over a given time period. Found under the Ratings & Risk tab.
- Turnover: Measure of the percentage of the fund's holdings that changed over the previous year. Funds that trade frequently tend to incur higher capital gains tax bills for their shareholders. (Relevant only for funds held in taxable accounts.)
Foreign-Stock Mutual Funds and ETFs
Key performance benchmarks
- Foreign stocks in developed markets: MSCI EAFE Index
- Foreign stocks in emerging markets: MSCI Emerging Market Index
- All foreign stocks: FTSE All-World ex-US Index
Key metrics are the same as for domestic-stock mutual funds and ETFs in addition to the following forward-looking metric
- World Regions: Found under the Portfolio tab, includes a breakdown of the fund's holdings by region and market classification. This is particularly useful in determining how much exposure the fund has to emerging-markets stocks, which tend to be more volatile than those from developed markets.
Bond Mutual Funds and ETFs
Key benchmark
- U.S. investment-grade bonds: Barclays U.S. Aggregate Bond Index
Key forward-looking metrics
- Average effective duration: Measure of the interest-rate sensitivity of a bond fund's portfolio. Generally, a fund with an average effective duration of five years can be expected to lose 5% of its value for every 1% that interest rates rise. However, that loss will be offset by the one-percentage-point rise in yield for a net loss of about 4%.
- Portfolio statistics: Found under the Portfolio tab, includes a breakdown of the portfolio's asset allocation and information about the credit quality, rate sensitivity, and type of its holdings.
- 30-Day SEC Yield: Most up-to-date reading of how much the fund's holdings pay out annually.
- Expense ratio: See domestic-stock mutual funds and ETFs section.
Key backward-looking metric
- Morningstar Rating for funds (star rating): See domestic-stock mutual funds and ETFs section.
Last Steps
Once you've reviewed your holdings using the key metrics and benchmarks mentioned above, it's decision time. If you find that some of your holdings are consistently underperforming, or not behaving as you'd anticipated--for example, moving in lockstep with your other holdings when you expected them to zig while others zag--it may be time to make changes. Likewise, if you find, after looking at some of the key metrics outlined above, that your stock or fund isn't delivering what you expected--perhaps it's more volatile or just doesn't fit in with your overall allocation any more--you may want to get rid of it.
But as you review your retirement portfolio, always keep in mind the big picture. Ideally, your portfolio holdings will complement one another and function as a unit. Making adjustments along the way is fine, but avoid the temptation to make changes for change's sake. Repeatedly dumping short-term underperformers and buying today's hot stock or fund is a recipe for long-term portfolio underperformance. So, use the information described here to make smart, well-considered choices. And for more on deciding when to sell a fund, see this video with Morningstar's Christine Benz.
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