David Snowball, PhD, publisher of MutualFundObserver.com, an independent mutual fund–analysis website that tracks 36,000 investment products. He also is professor of communications studies at Augustana College, Rock Island, Illinois.
Has your investment portfolio become an unwieldy mishmash of too many funds? Investment pro David Snowball, PhD, says that if you are overwhelmed by the complexity of your portfolio, all that you really need to successfully navigate today’s volatile financial markets is one, two or three easy-to-understand mutual funds covering US stocks…US or global bonds…and, if you opt for three funds, foreign stocks.
Advantages of streamlining…
Better returns. Over the past three decades through December 31, 2019, the S&P 500 Index had annualized returns of 10%. But individual stock fund investors averaged just an annualized 5.4%, according to financial research firm Dalbar. The Bloomberg-Barclays US Aggregate Bond Index had an annualized 5.9% versus 0.4% for bond-fund investors. Reason for that vast underperformance: Investors often jump in and out of markets at the wrong times, chasing hot returns or trying to avoid downturns. Having just a few well-diversified funds lowers the temptation to be a trader, constantly buying and selling fund shares in order to boost returns.
Less effort. You don’t have to constantly monitor the markets or spend as much time researching and evaluating a boatload of investments. Minimal expertise is required. And when you die, you won’t complicate the lives of your beneficiaries with an overly complex portfolio.
How to Create a Simple Portfolio
Start by consolidating your investment accounts at one brokerage firm…and roll old 401(k) assets and IRAs into a single IRA.
Next, decide whether you want to go with a one-, two- or three-fund portfolio, in both taxable and tax-advantaged accounts. One fund is all that many investors really need, especially if you have a long time horizon until you will need the money. As you age and your circumstances and tolerance for risk change, carrying two or three funds can give you more diversification and the ability to shift toward lower-risk bonds. But it also requires a bit more oversight.
Use low-cost actively managed mutual funds that do relatively well in all types of economic environments and have a history of outperforming the broad markets. Many investors prefer index funds or passively managed exchange-traded funds (ETFs), but I think the next 10 years are likely to be more challenging and volatile than the past decade. So I prefer funds that allow the managers to make defensive moves to protect their portfolios during market pullbacks. Note: If you want to use index funds or ETFs, see below.
The One-Fund Solution
Best for: Investors who want things to be as simple and hands-off as possible.
What to do: Invest in a balanced mutual fund that holds a mix of about 60% stocks and 40% bonds, the same allocation plan that giant pension plans use. The fund manager oversees the stock-bond mix, so you don’t have to rebalance your allocations.
Basic fund: Dodge & Cox Balanced (DODBX), launched in 1931, keeps about 60% of assets in undervalued large US companies with strong balance sheets and good growth potential. The other 40% goes into US Treasuries and high-quality corporate bonds. Performance: 7.3%.*
More conservative balanced fund: Vanguard Wellesley (VWINX). Even the most nervous investor will find this easy to own no matter how badly the stock market behaves. It keeps 60% of assets in corporate and government debt and 40% in blue-chip stocks. In its 50-year history, the fund had only seven years with losses (versus the S&P 500 Index, with 10 years in losses) and never more than a 10% loss in any year. Performance: 7.2%.
The Two-Fund Solution
Best for: Investors who want control over how much of their assets they invest in stocks and bonds. Owning two funds requires that you rebalance your portfolio at least once a year to maintain your desired stock and bond mix.
What to do: Invest in a US stock fund and a US bond fund. Take a risk tolerance test to determine how much of your money to allocate to each. You can find the tests on most major brokerage websites such as Charles Schwab or Vanguard.
Basic stock fund: Jensen Quality Growth (JENRX) invests in fast-growing large companies that have strong profitability and advantages over competitors that can fuel steady earnings. Performance: 11%.
Basic bond fund: Harbor Bond (HABDX), managed by bond-fund giant Pimco, holds 1,000 high-quality US government and corporate bonds…and tries to generate slightly higher yields and better total returns than the broad bond market by adding slightly riskier bonds. Recent yield: 2.2%. Performance: 4.1%.
For more conservative investors…
Basic stock fund: Parnassus Core Equity Investor (PRBLX). For more than 25 years, the fund has used a socially responsible investment strategy, avoiding companies that make alcohol, tobacco and weapons, and focusing on those that treat their employees and the environment well. The fund has matched the returns of the S&P 500 with about 20% less volatility. Performance: 10.8%.
Basic bond fund: Fidelity Total Bond (FTBFX) practices a similar strategy as Harbor Bond but experiences less volatility because it invests more broadly, with more than 2,500 bonds, and holds about 5% in cash. Recent yield: 2.9%. Performance: 4.4%.
The Three-Fund Solution
Best for: Investors willing to put up with more volatility in order to create a more diversified portfolio.
What to do: Buy a US stock fund…a global bond fund…and a foreign stock fund. This allows you even more flexibility in allocating between more aggressive and conservative investments but also requires a bit more decision-making and annual rebalancing.
Basic US stock fund: Vanguard Dividend Growth (VDIGX) invests in cash-rich companies that are growing fast enough to be able to keep boosting their dividends over time. Performance: 11%.
Basic foreign stock fund: T. Rowe Price Overseas Stock (TROSX) invests in a mix of fast-growing young companies and more stable, mature ones. It keeps the majority of assets in Europe and the UK, with a small exposure to emerging markets. Performance: 3.3%.
Basic global bond fund: Dodge & Cox Global Bond (DODLX) looks for bargain-priced stocks, investing roughly half its assets in the US and the rest overseas. Holdings are split between corporate and government debt. Although the fund was launched in 2014, its managers have run the stellar Dodge & Cox Income Fund for about 30 years. Recent yield: 3.7%. Five-year performance: 3.4%.
For more conservative investors…
US stock fund: T. Rowe Price Dividend Growth (PRDGX) uses a similar investment style as the Vanguard fund above. But it invests in twice as many stocks and keeps 5% of its assets in cash, both strategies aimed at muting volatility. Performance: 10.8%.
Foreign stock fund: Tweedy, Browne Global Value (TBGVX) has used a Warren Buffett–like approach for nearly 30 years, investing in cheap European and Asian dividend-paying stocks. It’s less volatile than the T. Rowe Price Overseas Stock fund mentioned above because it holds as much as 10% in cash if it can’t find bargains…and it hedges its currency risk. Performance: 4.5%.
Global bond fund: Pimco Income (PONRX) maintains a much more diversified portfolio than the Dodge & Cox fund above, investing in more than 7,000 bonds, with about 25% in US government debt and the rest spread around the world, ranging from mortgage-related securities to foreign government debt. Recent yield: 3.5%. Performance: 6.6%.
Index Fund Options
Instead of investing in actively managed funds, you can construct a simple portfolio at most major fund families using their in-house index funds or exchange-traded funds (ETFs). Although such passively managed funds are not best for rough patches in the market, they are good for capturing long-term gains. For example, to build a one-fund portfolio at Vanguard, use the Vanguard Balanced Index (VBIAX), which has 60% of its assets in stocks and 40% in bonds. For a two-fund portfolio, use the Vanguard Total Stock Market Index (VTSMX) and the Vanguard Total Bond Market Index (VBTLX). For a three-fund portfolio, use the funds in the two-fund portfolio and add the Vanguard Total International Stock Index (VGTSX).
*All performance figures are 10-year annualized returns through April 24, 2020, unless otherwise noted.