Portfolio Building, Part II: Brick by Brick

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 II

Last time, we discussed a rule of thumb for what some have suggested is a good guide to adjusting your portfolio as you age.

110-age=% of your portfolio that should be in stocks+funds combined

Let me be clear what we are discussing here—this is all in regards to your personal investment portfolio, not your workplace retirement account (401K, 403B, 457B, etc—-much more on this in a later post).

That’s all well and good or arguable or even ultimately utter rubbish. (I think it’s a perfectly fine guide personally. For some, it may seem too aggressive in their older, post-retirement age though my counterargument is that you will likely live very long after retirement if you retire in your sixties.

What I want to focus on instead is what to do in terms of stocks and funds in your retirement portfolio regardless of what percentage they may hold.

For some of you, you already have your favorite funds or even stocks that have performed well and are way ahead of the game (or at least you hope). For others, you may not know at all and would then rely on a financial advisor to help get you into the right securities. There may be others in between that aren’t sure if they want a financial advisor (more about that in a future post), aren’t sure if what they are in via their financial advisor is best suited for them, or simply aren’t sure what their money should be in.  

One piece of advice…

The non-funds part of your investment portfolio should be held in bonds and cash. (Some cash should ALWAYS (note the absolutism employed here which is exceedingly rare for me, but is appropriate in this case) be held back for any time great investing opportunities come up such as when there is a dip in the market leading to a price of a stock or fund that is great, not just good. The bonds should be just that: bonds.

Do not confuse bonds with bond funds.

Bond funds are what they sound like—funds composed of bonds with different interest rates and maturity dates where payouts are streaming in as more purchases are made to keep profits and payouts going. Bond funds have expenses attached to them that you pay for which will lower your returns as well as the fact that bond funds can actually drop in value (often when interest rates rise since interest rates and bond prices/value are inversely related) just like mutual funds or stocks.

If you want bond funds (and, personally, I detest them as they are lower performing securities with all the disadvantages of funds [have to pay fees and can lose both your gains and even your original investment] with all the low returns of bonds), then ensure they are a component of the funds portion of your investment portfolio, not the non-funds portion, because that’s exactly what they are.   

So, let’s say you’re forty, which means you’re earning good money, possibly married, possibly with kids, and now having an investment portfolio with 70% stocks/funds, 20% bonds (which you decided to put into triple tax free municipal bonds—all of which will be local to you which would mean that specific ones cannot even be named), and 10% cash for that great deal that may be lurking around the next quarter.

So what is that 70% stocks/funds portion actually made of?

Well, that goes back to your risk tolerance and how satisfied (or unhappy) you are with matching or keeping up with the returns of the S&P 500.

If you’re really happy with just what the S&P 500 is doing, then put all 70% in a S&P 500 index fund. The key is to pick the cheapest one possible, so that fees don’t destroy your returns over the next quarter of a century (remember, for better or for worse, in this example, you’re forty years old–lot of working years ahead of you which is good as you’re at the height of your medical career and have both plenty of expenses ahead of you and plenty of time and opportunities to hit your Magic Number).

If you’re seeking bigger/better returns than the S&P 500 provides, there are a few avenues available to you as long as you realize that necessarily this increases risk of losing gains made elsewhere or even your original investment.  

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

SR: WHy the hell would I want to invest in ball cap companies? I don’t even like wearing them.

PWT: Oh boy…

You’ll see all publicly traded companies characterized by what is known as market capitalization. Market capitalization in a publicly traded company is calculated by multiplying the number of shares available for trading/sale (ie, the outstanding shares) times the share price of the stock. Since the stock price varies from day to day, obviously the market capitalization of any company varies daily as well (even hour to hour or by the minute). (Market capitalization isn’t a great way to value a company for multiple reasons including the fact that it doesn’t take into account the debt the company carries at any given time, but more on this at a later post).

Small market capitalization companies (ie, small caps)=<$2 billion

And two lesser used company terms:

Nano caps<$50 million

Micro caps=$50 million-$2 billion

Mid caps=$2 billion-$10 billion

Large caps>$10 billion

Mega caps>$200-$300 billion (it’s arguable on the cutoff especially since it’s a newer term that holds no real value in terms of funds, etc being set up to follow just these companies since there is no growth in these companies given how big they already are)

SR: I guess a million dollars isn’t what it used to be…

PWT: Yeah. Tell me about it.N

Now that we have reached a climax, let me disappoint you all and we will conclude building a market beating portfolio (or, at least, we hope) next post.

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…