Building a mutual fund portfolio
Posted on December 9, 2007 in the Investing, Mutual Funds category
.When building their mutual fund portfolio many new investors make two common mistakes.
The first mistake that investors make is not putting their most aggressive growth funds in their retirement accounts. By law, mutual funds must pass to shareholders at least 98% of dividends and capital gains earned in a year. If you hold your aggressive funds in a tax-deferred account you will not have this tax burden, giving you maximum growth from your investments.
The second common mistake occurs when investors try to spread their risk amongst several different types of investments (a good idea), but instead buy similar types of funds in two or three accounts. Thus they actually end up INCREASING the risk level of their portfolio, not decreasing it.
Many investors today have more than one investment account. A typical household could have easily four different investment accounts. Usually there is at least one company retirement account through work, an IRA/Rollover account, and a college saving account and a taxable account. When developing and designing your portfolio, you need to be aware of all your investments, not just those holdings in one particular account. Your investments in your 401k should compliment those investments in both your IRA account and taxable account, not duplicate them. Also, if you are married and have separate retirement accounts, take these accounts into consideration when designing your portfolio.
Designing your Retirement Portfolio
As I mentioned above, your retirement account(s) are where you’re most aggressive growth funds should be held. Retirement planning is a long-term proposition so you can be a little more aggressive with your planning. If you retire today at 60, you still have another 20-25 years to live. Thus your money needs to continue to grow over the 20-25 years. Retirement accounts are not the place for conservative investments like money markets.
In designing a mutual fund retirement portfolio I would first start with an index fund that tracks the S&P 500. If you can only have one fund in your retirement account, an S&P 500 index fund is the one to have. The most well known index fund is the Vanguard S&P index fund, which has managed to beat 95% of all equity funds over the past three years. Most fund families now have their own index fund today. Make sure that the index fund that your plan offers has low expense fees (less than 0.50% management fee). The lower the management fee, the greater your opportunity for high returns.
The S&P 500 index fund invests in 500 large cap stocks. The next two additions to your retirement portfolio(s) should compliment, not duplicate, the S&P 500 index fund. Thus I would suggest adding a value fund and a diversified international stock fund.
Value funds (they used to be called Growth and income funds) are designed to pursue long-term growth as well as regular dividend income. The regular dividend income usually me that a growth & income fund will not fall as far or as quickly as an index fund in volatile markets like we are currently experiencing. I personally have been a long time fan of the Muhlenkamp fund. When comparing fund’s that are available to you through your retirement accounts, make sure to follow these steps.
If the Muhlenkamp fund is not available for your retirement plan, look at our post on how to pick a mutual fund for other options.
The index and value funds are investing primarily in U.S. companies. To add balance to your account(s) and potentially increase your returns, the next step is to add a diversified international stock fund. By diversified I mean that the international fund is not limited to one part of the world like a European or Latin America fund is.
Also, I want a fund that does not invest in the U.S. Remember, we are looking to compliment not copy. Good international funds with solid track records are harder to find in retirement plans than domestic (U.S.) funds. Following the same steps you took with picking a value fund will help guide you through the maze.
What you invest in next depends on the size of your retirement(s) accounts as well as whether you have any shares of your employees stock in your retirement account.
For example, if your employer is a large-cap firm, then you might consider looking for a small-cap fund to compliment the company shares. If your employer is small company then a larger growth fund might be more appropriate. The key is complementing your investments not duplicating them.
Taxable Accounts
Your taxable account(s) is where your money market account and short-term fixed income investment ‘s like CD’s or Treasury bond should be. This might seem very conservative to some, but remember that the money market and/or Treasury Bonds reflect your emergency money and cash on hand.
For investment opportunities in your taxable account, keep in mind the investments in your retirement accounts(s).
For example if you are looking to compliment your diversified international fund that is in your retirement account then a good choice would be regional international fund like a European fund of an Asian fund.
Taxable accounts are also perfect places for long-term individual stocks. In the coming weeks we will look at how to put together a successful stock portfolio.
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