First things first.
Most investors still spend way too much time trying to identify top-performing mutual funds and not nearly enough time thinking about whether they own the right mix of funds.
Want to do it right? Here are some tips on building a winning mutual-fund portfolio:
– Aim before you fire. Most folks shouldn’t own just one portfolio of funds. Instead, they might own three or four portfolios, each earmarked for a different goal.
These portfolios could be as simple as a single fund, such as a blue-chip stock fund for a child’s college savings. But for other goals, especially retirement, you might own a fistful of funds that cover a host of stock and bond-market sectors.
– Get the big decision right. Why bother with different portfolios? How you manage money should depend heavily on how soon you will need your cash.
If you’re saving for a distant goal, such as a toddler’s college education, lean toward stocks. After all, the more you have in stocks, the higher your long-run results are likely to be.
But if you load up on stocks, you also run the risk of a big short-term hit. Result? If you plan to buy a house in the next five years, you ought to steer clear of stocks and instead stash your future house down payment in more conservative investments, like a money-market fund or a short-term bond fund.
– Pick your risks. Many experts say you should pay close attention to how much risk is taken by each fund you own. But I wouldn’t bother.
True, if you have 20 percent of your portfolio in a high-octane growth-stock fund, that portion of your money could be in for a wild ride. But if the rest of your savings are sitting in a money-market fund, your overall portfolio still will be fairly sedate.
The bottom line? Just as your asset allocation among stocks, bonds and money funds heavily influences your long-run results, so it also will be the biggest factor in your portfolio’s short-term price gyrations.
– Play the numbers game. With more than 8,000 stock and bond funds to choose from, finding a top-notch fund can be baffling. What to do? Before you start picking funds, decide what sort of funds you want to own. That, in turn, will depend on how many funds you are willing to buy.
Suppose you’re looking to buy bonds and you settle on a three-fund portfolio.
Your desired mix includes 50 percent in a high-quality corporate bond fund, 25 percent in a high-yield, or junk-bond, fund and 25 percent in a foreign-bond fund.
Having decided what types of funds you want, you then buy the best possible funds within each category.
– Watch for wanderers. Some funds have far more flexible investment charters than others.
Many balanced and asset-allocation funds shift between stocks and bonds, depending on which looks like a better value.
Similarly, global funds change their mix of U.S. and foreign stocks.
Seem attractive?
Not to me. I’m skeptical that anybody can outguess the market.
Moreover, if you own funds that make big market bets, you may find that these bets radically alter the portfolio allocations that you originally settled on.
As a result, I prefer funds with stricter investment charters.
For instance, to get foreign-stock exposure, I favor international funds over global funds because international funds invest exclusively abroad; global funds keep part of their money in U.S. stocks.
– Check under the hood. Even if you buy funds with narrow investment charters, it’s still worth taking a close look at each fund’s portfolio.
You may find that one of your U.S. stock funds has, say, 10 percent of its portfolio invested abroad or 20 percent in cash.
You can figure each fund’s idiosyncrasies into your portfolio allocations.
If your U.S. stock funds tend to hold a lot of cash or a hefty dose of foreign stocks, you can compensate by keeping less of your portfolio in international funds and money-market funds.
But if you really want to control your portfolio allocations, consider index funds.
These simply buy the stocks that constitute a market index in an effort to match its performance.
When you buy an index fund, you can’t be sure how the market will perform.
But you do know that whatever the market delivers, that’s pretty much what you will get.
– Look before you leap. If you’re not careful, you can unintentionally make a big bet on a single market sector.
Every year, make a point of classifying your funds and then seeing what percentage of your portfolio is invested in each sector.
For instance, you might assume that you are well-diversified because you own five U.S. stock funds.
But if each of those funds favors smaller-company stocks, you are actually making a sizable bet on a sliver of the market.
