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Across My Desk: Midyear Portfolio Checkup

With half of this year behind us, some words of wisdom from Morningstar about performance and a midyear portfolio checkup.

First, performance:

"Morningstar, June 29: The first half of 2007 was a roller coaster. After dropping 3.5% on February 27, the largest loss in one day since the 9/11 tragedy, the S&P 500 Index roared back to life and now sits 7.3% above where we started the year. As we've done in the past, we've examined the dollar changes in stock market values to derive our value creators and destroyers for the year."

On to that checkup:

"Many of the basic rules of investing are counterintuitive. For example, rising interest rates may be good news for those shopping for certificates of deposit and other short-term savings vehicles, but they're generally bad for bond funds. And here's another zinger: The lazy investor is often more successful than the hard-working one.

If you're checking in on your portfolio holdings every day--or worse yet, throughout the day--you may be tempted to trade more than you need to. In turn, you may run up high tax and transaction costs, and you're also more likely to chase hot-performing stocks and funds in the hope that they'll continue to outperform. That can be a recipe for disaster.

You should plan to rebalance your portfolio--remove money from those investments that have performed well and plow it into your portfolio's underachievers--every 12 to 18 months.

Observe the following five steps as you conduct a review of your portfolio. Take notes as you go along, because you'll want to refer to them when you rebalance later this year.

1. Make sure your asset mix is in line with your target.

One of the most important determinants of whether your portfolio is positioned to meet your goals is your asset allocation--how much you hold in stocks, bonds, and cash.... Many U.S. stock funds are holding cash these days, so more of your portfolio may be sitting on the sidelines than you intended. Similarly, lots of U.S. stock managers are scooping up foreign stocks, so your portfolio's overseas holdings may have increased. That's not a bad thing, but it could signal that you don't need to add more dedicated foreign-stock exposure to your portfolio.

2. X-ray your portfolio.

Once you've assessed your portfolio's asset allocation, turn your attention to how your stock and bond holdings are positioned.

3. Review your individual holdings.

Once you've checked out your aggregate portfolio's positioning, it's time to conduct a quick checkup on each of your individual holdings.

Morningstar's Analyst Reports--free to Morningstar.com Premium Members--are a quick and easy way to get a handle on the key issues at most prominent mutual funds, exchange-traded funds, and publicly traded companies; our analysts will also tell you whether they think a security is worth owning or not.

4. Examine performance.

It's a big mistake to focus too much attention on short-term performance, but your quarterly or semiannual portfolio review should include a quick assessment of which of your holdings are providing the biggest boost to or drag on your portfolio's overall return. It's fine to glance at year-to-date performance, but focus most of your attention on the longer-term numbers--each holding's return over the past three and five years relative to that of other offerings within that same category. Also take note of absolute returns. Which of your holdings have contributed the most--or detracted the most--from your portfolio's bottom line? Sustained underperformance can be an indication that something's seriously amiss with one of your holdings.

5. Plan your next move.

After you've reviewed your portfolio's current status, it's time to plan your next move. It's not likely that you'll uncover a portfolio problem you need to address right away, but you should make sure to schedule a time to rebalance your portfolio. Conventional financial-planning wisdom holds that the best time to rebalance is at year-end, with an eye toward harvesting any losses to offset capital gains elsewhere in your portfolio. But if you'll have more time to focus at some other time of the year--say, earlier in the fourth quarter--by all means do so."

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