How to Build a Better Portfolio
The key to successful investing is in how you divvy your assets between U.S. stocks, foreign stocks, bonds, cash and other types of investments.
This is shaping up to be a tough year for investors. Year-to-date through September 9, the U.S. stock market was off about 7%, and foreign stocks were down even more. But if you owned, say, T. Rowe Price Personal Strategy Balanced (symbol TRPBX), a well-diversified fund that holds stocks, bonds and cash, you’d have lost only 4%.
The fund’s long-term results have been even more impressive. Over the past decade, it gained 5.8% annualized, compared with 2.6% for Standard & Poor’s 500-stock index. And the fund beat the index while being 30% less volatile.
What the Price fund accomplished—beating the stock market with less risk than the market—is every investor’s dream. Of course, not every ten-year period will look like the last one, and not every fund will perform as well as this fund did. The point is that diversification does work. Plus, a diversified portfolio will gyrate less than one that holds only stocks, lessening the chance that you’ll bail when the market is tanking and lock in your losses.
Most people worry too much about the specific stocks, bonds and funds that go into a portfolio. In fact, 90% of your performance stems from how you divvy up assets into major investment classes—U.S. stocks, foreign stocks, bonds, cash and so on.
The key is to vary the ingredients and their amounts in a way that’s most suitable for you and your goals. Say you’re especially sensitive to volatility. As a rule, you will want to put less in stocks and more in bonds and cash. But if you tilt toward these presumably safer investments, your long-term gains will probably be lower than they would be with a stock-heavy portfolio.
Once you’ve set up your portfolio, you generally should tinker with it only for two reasons. First, you’ll want to rebalance yearly, which means selling some of your winners and reinvesting the proceeds in your losers. This is a proven, though not perfect, method for selling high and buying low.
Second, you’ll sometimes want to add new types of assets to the mix. Ten years ago, few people owned emerging-markets stocks, and now they’re considered a must-have asset class by no less an investing icon than Burton Malkiel, author of the classic book A Random Walk Down Wall Street. Likewise, many experts say that a well-rounded portfolio should include commodities because holding items such as gold, oil and wheat lowers volatility. The portfolios below, designed for three kinds of investors, are a good place to start.