Forget Razzle-Dazzle: What Should Be Your Core Mutual Funds?


Bill Miller and most other 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 adopt a similar mindset when building their own portfolios.

True, it's hard to open the business section without seeing an article about spiking oil prices or China's growth. But should you run out and 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 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 fund manager decide whether the next big thing is worth investing in.

Simplifying your investment life isn't terribly complicated 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) retirement 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, 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 to cut down on the number of stock or bond holdings you have to monitor, and you'll also be able to ensure that each of your picks is truly the best of the breed.

For example, say your spouse's retirement plan lacks worthwhile bond holdings but has a few terrific core stock-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 that 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.

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'd 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.

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 percent the previous month? Maybe not. But that would mean $100 less working for you when your investments rebounded.

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 sales load, you'll pay that amount on each and every investment. Perhaps more important, by making smaller fund purchases you might not be eligible for sales charge discounts that are frequently available to those who are investing larger sums.

Here are some things to consider:

• Avoid faddish funds designed to capitalize on short-term market trends. Instead, stick with core stock and bond funds that you don't need to babysit.

• Consider all-in-one funds, particularly target-maturity funds, which grow more conservative as you get close to your goal.

• Index funds make great choices for investors who don't want to spend a lot of time managing their portfolios.

• If you have several portfolios geared toward the same time horizon, manage them as a unified whole, emphasizing the best options available to you in each account.

• Whenever you make an investment, write down why you bought it. If it no longer fits your reasons for buying, it's probably a good candidate for selling.

• Consolidate your investments with a single fund family or fund supermarket.

• Simplify your life by setting up an automatic investment plan. Dollar-cost averaging takes the emotion out of investing, and should produce better returns over time than buying and selling erratically.

This article, courtesy of ARA Content, was excerpted from "Morningstar Guide to Mutual Funds, Second Edition: Five-Star Strategies for Success."



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