By Christine Benz
Most of us would do well to adopt a streamlined approach to running our own portfolios. After all, wouldn't you prefer to have a portfolio devoted to a short list of those investments in which you have the highest degree of confidence, one that you can hold through thick and thin, no matter what the market serves up?
True enough, building such a portfolio is easier said than done. Life is messy, and as our financial lives get more complicated, most of us end up managing multiple accounts--our own 401(k) plans and those of our spouses, IRAs, 529s, and various taxable accounts, for example. But by following a few guidelines, you can set up a minimalist portfolio that you can really count on.
Stick with the Basics
Top portfolio managers will tell you that there's a lot of day-to-day "noise" in the market, most of which has little to no bearing on the actual value of their holdings. Individual investors would do well to keep this in mind when building their own portfolios.
True, it's hard to open the paper without seeing an article about TARP, bank stress tests, or whether the housing market will bounce back. But should you run out to buy an investment that's specifically designed to focus on one of those trends, such as a sector or regional fund? Probably not. Any such offerings tend to be expensive and exceptionally volatile, and individual investors have a record of buying them high and selling them low.
A better strategy, particularly if you're aiming to build a high-quality, low-maintenance portfolio, is to avoid these niche offerings altogether and instead focus on finding great core mutual funds--broadly diversified offerings with reasonable costs, seasoned management teams, and solid long-term risk/reward profiles. If you've done that, you can pretty much tune out the day-to-day noise and let your manager decide whether the next big thing is worth investing in or not.
Investigate One-Stop Funds
Of course, finding solid core funds is only part of the battle. Establishing and maintaining an asset mix suited to your particular investment objectives is another big task. That's why one-stop funds, particularly target-date funds, which "mature," or grow more conservative, as your goal draws near, make sense for so many investors. Because these are funds of funds that provide in a single package exposure to stock offerings (both foreign and U.S.), bond funds, and cash, they're ideally suited to investors looking to build streamlined portfolios.
And for busy people who don't have a lot of time to babysit their investments, target-date funds are ideal. Not only do they arrive at a stock/bond/cash mix that's appropriate for your time horizon, but they also gradually make that asset allocation more conservative as the target date draws near. You simply buy a fund that matches your target date--say, your child's anticipated college enrollment date or your planned retirement date--and tune out.
These funds aren't created equally; they can be costly and draw upon lackluster fund lineups, and a few funds geared toward pre-retirees lost huge sums last year. However, we think those in target funds from Vanguard (less aggressive asset allocations) and T. Rowe Price (more aggressive asset allocations) are in good hands.
If you'd like to simplify your investment life but aren't ready to cede as much control as you're required to with a target-maturity fund, index funds could be your answer. With an indexing approach, you accept the market's return (or rather, the market's return less any fund expenses) rather than try to beat it. That's not a panacea: Investors in S&P 500 Index funds lost more than a third of their assets in 2008. But as Vanguard founder Jack Bogle has said, indexing is a way to ensure that you get your "fair share" of the market's return rather than forking it over to middlemen.
With index funds, you don't have to worry about manager changes. Or strategy changes. You always know how the fund is investing, no matter who is in charge. Many investors find indexing boring, but even investment junkies admit that index funds are among the lowest-maintenance investments around. The real work with indexing comes at the beginning of the process, when you're determining how much you want to hold in stocks, bonds, and so forth.
Take the Best and Leave the Rest
Simplifying your investment life isn't terribly complicated to do if you're managing a single retirement portfolio for yourself. But life is messy, with most investors juggling multiple portfolios and multiple goals at once. In addition to your own 401(k) plan, for example, you might also be overseeing an IRA for yourself and your spouse, a child's college-savings plan, and your household's taxable assets.
If you're like many investors, you're running each of these various accounts as well-diversified portfolios unto themselves. That's not unreasonable. But to help counteract portfolio sprawl, you might consider managing all of your accounts that share the same time horizon as a single portfolio, a unified whole. In so doing, you'll be able cut down on the number of holdings that you have to monitor, and you'll also be able to ensure that each of your picks is truly best of breed.
For example, say your spouse's retirement plan lacks worthwhile bond holdings but has a few terrific core equity-fund choices; yours has several solid bond picks. If that's the case, you may want to stash all of your spouse's assets in the stock funds while allocating a large percentage of your own 401(k) plan to bond funds.
The key to making this strategy work is to use tools such as Morningstar.com's Portfolio Manager and Instant X-Ray, which let you look at all of your accounts together, as a single portfolio. That way, you can see if your overall portfolio's asset allocation is in line with your target, and you can also determine whether you're adequately diversified across investment styles and sectors.
Jot Down Why You Own Each Investment
Simplification gurus preach that writing down our goals helps us organize our lives to meet those goals. The same can be said for investing: By writing down why you made an investment in the first place, you're more likely to make sure that the investment meets its original goal. If it isn't doing what you expected by sticking with a specific investment style and producing competitive long-term returns, you'll be ready to cut it loose. Noting why you bought the fund--to get large-cap growth exposure and consistently above-average returns from a manager who has been in charge for several years, for example--will help to instill discipline and eliminate some of the emotion that so often gets in the way of smart investing.
Say you bought Fidelity Contrafund (NASDAQ:FCNTX - News) to cover the costs of your daughter's education in 15 years. You chose the fund because it earned a Morningstar Rating of 5 stars, reflecting a good combination of returns and risk; its expenses were lower than the category average; and it has a very long-tenured manager in Will Danoff. Those are all good reasons. So you shouldn't even consider selling the fund unless it falls short on these points, and so far it hasn't.
To take the opposite case, maybe you bought Putnam International Growth & Income (NASDAQ:PNGAX - News) 10 years ago because you wanted some international exposure and you were attracted by Putnam's strong performance on its international funds. But since then, the fund's performance has been erratic, and Putnam's international team has seen a lot of upheaval. Because the fund is no longer meeting your main reasons for buying it, selling would be a reasonable choice. Other legitimate reasons to sell would be that a fund has hiked its expense ratio or assets have gotten so bloated that performance starts to suffer.
Consolidate Your Investments with a Single Firm or Supermarket
By investing with only one fund supermarket or fund family, you eliminate excess complexity, cutting back on paperwork and filing. And the consolidated statements you'll receive can make tax time much easier, too. Instead of pulling together taxable distributions and gains from different statements, you'll have them all in one place.
If you want to stick with just one fund family, consider one of the big ones, such as Fidelity, Vanguard, or T. Rowe Price. These no-load families are all relatively low-cost, with Vanguard being the cheapskate champion, and each offers a diverse lineup of mutual funds. If you would rather pick and choose among fund families, then a mutual fund supermarket might be your best option. Fund supermarkets bring together funds from a variety of fund groups.
Put Your Investments on Autopilot
You may pay your electric and water bills automatically; why not invest the same way? You won't have to send a check out every month, every quarter, or every year. There's an added benefit to investing relatively small amounts on a regular basis (also called dollar-cost averaging): You may actually invest more than you would if you plunked down a lump sum, and at more opportune times. When you're dollar-cost averaging, you're putting dollars to work no matter what's going on in the market. You have effectively put on blinders against short-term market swings: Whether the market is going up or going down, $100 (or whatever amount you choose to invest) is going into your fund every month no matter what. That's discipline. Would you be able to write a check for $100 if your fund had lost 15% the previous month? Maybe not. But that would mean $100 less working for you when your investments rebounded.
For example, an investor who put in $600 up front in January would have gotten 60 shares at $10 per share. Those shares were worth $12 in June, so her investment was worth $720. If she had dollar-cost averaged her investment, putting in $100 per month, she would have purchased some of her shares on the cheap and wound up with 62.1 shares in June. At $12 per share, she would have had $745.20--$25 more than if she had invested a lump sum at the beginning.
Be careful about using a dollar-cost averaging program if you use a broker or advisor to buy and sell shares, however. If you're paying a front-end load, you'll pay that amount on each and every investment. Perhaps more important, by making smaller purchases you might not be eligible for sales-charge discounts that are frequently available to those who are investing larger sums.
This is a version of a chapter that appeared in the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success.
Christine Benz does not own shares in any of the securities mentioned above.