Portfolio Building, Part III: More Bricks

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

Portfolio Building, Part III

Let’s jump right into it since some of you may have felt robbed last time you checked in. The example we used was following the rule/suggestion of 110-age=% of stocks/funds in your portfolio with you being a forty (Ugh or Yay!) year old. So 70% stocks/funds are what you will need for that age if you are following this suggestion.

If you’re not happy with a steady return that matches the S&P 500 in exchange for a modestly-moderately increased risk of loss, then here is a possible approach.

In danger of quoting myself from even just my last post….

The standard avenues in the realm of stocks/funds for returns better than the S&P 500 (drumroll please) are the following:

  1. Small cap funds
  2. Mid cap funds
  3. International funds
  4. Stocks

What proportion you want of each will depend again on your risk tolerance, but let’s have the facts laid out first before you decide anything.

Small caps have historically beaten the S&P 500 over the past century on average and in five of the past eight decades by a wide margin whereas the three decades where they underperformed relative to the S&P 500, they barely lost out to the S&P 500.

There are value and growth companies/stocks at each market capitalization level. (To make simple examples by companies that everyone should have heard of, think of Amazon or Netflix as growth stocks and Johnson & Johnson or ExxonMobil as value stocks.)

There are value or growth funds at each level. To make things more confusing, there are also “blended” funds at each market cap level. They may be labeled as blended or just have the market cap level noted without any further designation such as “Blah blah blah Small Cap Fund” (with “Blah blah blah” standing in for the name of the company’s name such as Fidelity or Vanguard as example of two well known ones—sorry to lose you in my technical jargon). If you want a simple approach where there is as few moving parts as possible, you could do the following:

30% S&P 500 Index Fund

20% Mid Cap (Blended) Fund

20% Small Cap Blended Fund

20% Bonds

10% Cash

This ensures what should be a decent return above the S&P 500, but with only a modestly higher risk of loss above the S&P 500.

International funds may increase your return, but will invariably increase your risk of loss as well. They are impossible to give you a historical return on given that there are multitudes of international funds (eg, All World, Europe, Asia, Middle East, Latin America, etc.), multiple companies (Fidelity, Vanguard, T. Rowe Price, etc.), and different investing styles/types (eg, passive, active, growth, value, mid cap, small cap, large cap). For international funds, you’ll have to find the exact one you’re thinking of and look up its historical performance data to see how it’s done over the past years or decades even.

Better yet, a financial advisor will do all of the footwork for you and advise you what to put it in. Just check how it has done for the past year, five years, ten years, and “life of the fund” (ie, however long it has been around whether 7 years or 70 years) and ask why this specific region/country (read up on the area if you know nothing about it) or why this certain investing style (value instead of growth or vice versa, small cap instead of large cap), and as ALWAYS, check the expense ratio of the fund and make sure you understand what the true returns of said fund only after you subtract out the expense ratio.

As you can see it takes a bit of work or money (the fees you pay your financial advisor) to make sure you’re putting money into the “right” (whatever that means) funds.

But, think of it this way: you work (among many other reasons) to make money or spend cash to invest in other things you value (eg, car, house, TV, phone, etc) that bring back to you enjoyment or value of many other kinds.

This work or deployed capital is exactly the same: you’re working to make money or spending money to get something in value (and, even better, something that will hopefully increase in value and not depreciate like most everything else you will buy).  

Personally, I’m an investing/personal finance nerd and enjoy finding great value in excellent funds at a good price. I don’t expect anyone else to be, but it’s important. This is your and your family’s financial future. Precious few things will be more important.

This little extra work is definitely worth it when you consider that the difference between a great company and a good company over the next 20-30 years would be enormous. Besides, it’s not supposed to be fun; after all, it’s called work for a reason. Moreover, it’s likely far easier than what you do in your day-to-day job and will pay far more years or even decades from now than a few hours of work.   

Let’s talk about several other fund only portfolios in the future.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…