Putting a portfolio together is similar to putting together a puzzle. There are many pieces and it appears daunting at first, but with a bit of patience, strategy, persistence, and time, one can finish the project with every piece in its proper place. As with every puzzle, each piece fits with its adjoining pieces. They all have their proper place. Your portfolio is a puzzle that needs to be completed.
Let's start with the big pieces. There are four basic asset classes you should consider as important pieces of a portfolio. Stocks, bonds, real estate, and cash. How much you own of those asset classes is up to the individual as they decide how much volatility they can tolerate as well as the challenge of staying up with inflation and their stage in life. Can you add other pieces? Yes, but should you?
The financial services industry has made it as convenient as possible to add other alternative investments like commodities, junk bonds, private REITs/ equity/credit, futures, cryptocurrency, insurance products like annuities and whole life, derivatives, etc. Here is a little secret that the industry would not like you to know. What is good for them, is not good for you. What is good for you, is not good for them.
So, what that means is adding more alternatives is likely to get you less. Another way to put it is less is more. I strongly recommend you keep your puzzle relatively simple for long term growth, managed volatility and of course, minimal cost, which we will discuss further as we go. Stick with publicly owned stocks, bonds, REITs and cash. Your puzzle will be much easier to complete and better for the long run.
So, let's start with the stocks (businesses). A good place to start is by owning an entire market like the United States. VTSAX does that. You get to own the United States of America in one very low cost index fund. Keeping roughly half your stock portfolio in that fund is a wise move. If you prefer to keep all of your stocks in that one fund, go right ahead. That will make your puzzle very easy to complete.
Adding more markets makes sense when you consider diversification and reduced volatility. Owning large international markets in VTIAX and small international markets in VFSAX makes good sense. Owning small companies with a value tilt has rewarded the average investor over time. You can do that with VSIAX. Could you stop there? You sure could. Then it is just a matter of figuring out how much per fund.
Before we talk about percentages, let's discuss publicly traded REITs, like VGSLX. This is actually a stock fund that owns stock in commercial real estate. It covers you on two different asset classes. Many people will want to own this type of fund because it can reduce volatility within a portfolio as it tends to go in different directions compared to large U.S. stocks, which is mainly what makes up VTSAX.
Now the percentages. This is a soft science so let's be clear on that. There is no perfect allocation looking forward, only looking back in time do we know what we should have owned. You want to set allocations within the stock portfolio that you will stick with no matter how bad a fund performs. It is critical to keep that in mind. You MUST stick with your allocations through good AND bad times.
Okay, with that said, here is a simple guide. 50% in VTSAX, 10% in VTIAX, 10% in VFSAX, 20% in VSIAX and 10% in VGSLX. That equals 100% of the stock portion of the portfolio. Can you tweak that a bit, expanding on the puzzle? Yes, but you don't have to, that simple approach diversifies you all over the world in stocks and commercial real estate in the U.S. at a very low cost. Now let's look at bonds.
This is simple. Own bonds to reduce the volatility and provide income on a monthly basis. VBTLX and VBIRX are two very good options. The first will be a bit more volatile and should produce slightly higher returns over time. You could pick one or the other or both if you like.The key is sticking with it as mentioned earlier even when interest rates are going up. Your bond returns will go down when that happens.
Why those funds? They own primarily U.S. government bonds that provide safety when markets are freaking out over whatever the bad news is at the time. Both of those returned over 5% in the tumultuous 2008. The stocks do well when times are good and the bonds provide a safe haven when shit is hitting the fan. I would avoid Junk bonds (high yield bonds). They drop when stocks drop.
What percent of a portfolio in bonds? Each person has to figure this out for themselves. If volatility doesn't bother you much, you may choose to have 0% to 20% of your portfolio in those bond funds. If volatility bothers you a lot, you might choose 50% to 80% in bonds. Just remember, there is no free lunch. The bonds are less volatile and will return much less over time than the more volatile stock funds.
Let's circle back and talk more about real estate. What about rental properties? If you are the handy kind of person who will work on your properties and you know value when you see it and you don't mind throwing some money into them here and there as needed, then yes, that might be an option worth considering. For the vast majority of people, VGSLX will be the best option. It will be easier to complete the puzzle.
That brings us to cash. Decide what percentage and then go find the best place to get the highest return on your cash while keeping it liquid for emergencies and withdrawals if you are retired. For many, VMFXX works just fine. It currently earns 5.3% at Vanguard. When cash is earning a high rate like right now, you might consider a higher cash allocation vs. bonds, paying less than 5% currently.
So, what does that look like when we look at the big picture? Let's say a retiree has decided they want 70% in stocks (includes REITs) to combat inflation, 20% in bonds for income and disinflation, and finally 10% in cash for liquidity and additional income. It might look something like 35% VTSAX, 7% VTIAX, 7% VFSAX, 14% VSIAX, 7% VGSLX, 20% VBIRX, and 10% VMFXX. The puzzle is complete!
I stated earlier I would come back and talk about costs. With every allocation you make, cut your cost as much as possible. That means sticking with index funds or ETFs at places like Vanguard, Fidelity or Schwab. It also means minimizing your transaction costs and taxes with minimal buying and selling over time. Own the right asset classes at the right costs as you buy and hold. Simple is good.
Let's wrap it up. The puzzle is waiting to be completed by YOU. Either pick up the knowledge yourself from the right sources described above or here so you can do it yourself or have someone help you do it who will not charge you an arm and a leg. The Giving Solution can serve those who need some help and the cost is FREE. Educate and take action. A beautiful puzzle awaits!
Stuff the lawyer wants me to say: Investing outside a bank or a credit union is not FDIC insured. You may lose the value in the investments you select. All information provided here is for informational purposes only. It is not an offer to buy or sell any of the securities, insurance products, or other products named. Translated: I am not selling anything! Educate yourself, research the information that you learned and finally make the right decisions that will benefit you and your family going forward.