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Last updated on February 24, 2004
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BASICS
Cures for the Common Portfolio
by Erin Burt If your portfolio seems a bit sluggish, maybe it's overweighted, suffering from fund glut or feeling neglected. We diagnose ten investing ills and offer simple remedies for each to get your portfolio back on its feet. 1. Investing without a strategy
2. Owning too many funds
3. Paying too much in fees
4. Taking on too much risk (or not achieving enough growth)
5. Failing to diversify
6. Neglecting your portfolio
7. Trading too frequently
8. Scattering retirement accounts
9. Buying/selling on emotion
10. Dragging your feet
1. Investing without a strategy. Not only is it important to invest with a goal in mind, say college, retirement or travel, but you'll need a strategy to get there.
If your goal is more than five years away, for example, you should invest in stocks or stock mutual funds (or both). But what kinds of stocks you select depend largely on your style. Are you a buy-and-hold investor? Solid blue chip companies may be for you. Looking for income? Dividend stocks are a good choice. As you approach your goal, you'll want to tone down your risk. Bond funds are a nice way to reduce volatility. Money market funds are a good selection for check-writing privileges. See Establish Your Game Plan for more advice on honing your strategy.
If you don't want to manage your plan yourself, you can invest in a so-called life-cycle fund which will tone down your risk automatcially as you near the target date. Read One-Stop Investing for more information.
2. Owning too many funds. It's easy to overestimate how many mutual funds you need to achieve diversification. Ideally, you should own about seven to eleven funds. More than that won't help much and can increase the record-keeping hassle. Use Fund Finder to screen for your starting five, which should represent different types of stocks:
- Large-cap growth -- fast-growing companies
- Small-cap growth -- smaller, fast-growing companies
- Large-cap value -- large companies selling at bargain prices
- Small-cap value -- smaller companies selling at bargain prices
- International -- foreign companies
To reduce risk, buy a bond fund invested in intermediate-term corporate bonds or intermediate-term tax-exempt bonds. For even more diversification, you can add depth with utility players, such as a fund that invests in junk bonds or real estate investment trusts.
For specific fund suggestions to reach your goals, see Kiplinger's Fund Portfolios.
Cull your funds with an eye on expenses and taxes. If you have two large-cap growth funds with similar returns, but one has a much higher expense ratio, dump it. High fees create a drag on returns (see below). If your funds are in an IRA you don't have to worry about the tax consequences. If they are not, try to offset gainers with losers.
3. Paying too much in fees. The average mutual fund charges 1.5% in expenses, according to Morningstar. Assuming your stock fund returns 10% annually, that means you would relinquish 15% of your yearly gain to fees. If your bond fund returns 3% on its portfolio and you pay the average fee, there goes half of your gain.
There's no need to pay more if you can get the same or better returns elsewhere for less. Take the number of dollars you have in a mutual fund and multiply that by the fund's expense ratio to learn how much you're spending for investment management. Then search for a fund with similar or better returns and risk profile but lower expenses, and make the same calculation. The difference is money in your pocket. If it's enough of an incentive, make the switch.
For suggestions on no-load funds with good records, see our Fund Portfolios. And for more information on fees, see Why Mutual Fund Expenses Matter.
For individual stocks, keep an eye on broker fees. Full-service brokers typically charge higher commissions than discount and online brokers. So if you are comfortable making your own investment decisions and don't want a broker's advice, consider switching to a discount or online broker. Regardless of what type you choose, watch out for miscellaneous fees, such as those for stock certificates, account inactivity or funds transfers. They too cut into your investment's return.
4. Taking on too much risk (or not achieving enough growth). You want to make sure your investments are on track to achieve your goals.
Your time horizon is the first factor to consider. If you're within five years of retirement, for example, investing 100% of your money in stocks is probably too risky. But if you have 25 years until you retire, allocating 40% of your portfolio to bonds might hinder your ability to build a comfortable nest egg in time. Test your risk tolerance to find the most effective allocation for your money. Remember, the higher the return you're aiming for, the more risk you must assume.
5. Failing to diversify. Although not putting all your eggs in one basket may seem like common sense, it can be hard to discipline yourself. Mutual funds, with their individual portfolios, are a good way to achieve diversification. Divide your holdings among those that invest in large, fast-growing companies, smaller, fast-growing companies, large companies selling at bargain prices, smaller companies selling at bargain prices and foreign companies. Maybe throw in a bond fund for balance. If you invest in stocks, use the same strategy, structuring your portfolio around those five types of stocks to spread the risk from the market's inevitable ups and downs.
Also, don't forget to check for overlap in your mutual fund investments, including those in your 401(k). If three or four of your mutual funds are invested in the same few stocks or sectors, your portfolio isn't nearly as diversified as you might think. To get a free look at where you stand, check the portfolio instant x-ray tool from Morningstar. For a deeper analysis, try software from Overlap Inc. ($165 a year).
6. Neglecting your portfolio. Even if you start out diversified, you need to reevaluate your portfolio at least once a year. Over time one group of investments will outperform the others -- say, large-cap growth stocks vs. bonds -- throwing your allocation out of whack. To restore it, sell shares of one type and buy the other.
While selling issues that are doing well may seem counterintuitive, rebalancing your assets helps you avoid investing on emotion and forces you to buy low and sell high, reducing the volatility of your portfolio.
7. Trading too frequently. During bull markets, chasing gains becomes much more enticing than sticking with your buy-and-hold investment strategy. After all, it seems so easy to make a buck with just a few quick trades.
But attempting to time the market or make a quick buck is gambling with your future. A better strategy for the long term is dollar-cost averaging. Set up a regular schedule of investing -- such as socking away a fixed amount of money each month -- and stick with it no matter what direction the market moves. This will ease your portfolio's volatility -- not to mention your stress level. And to further reduce your trigger-happy urges, stop watching your stocks' performance every day -- once a month or once a quarter will suffice.
Trading too frequently can also erode your returns because you'll pay commissions and fees on each transaction. Maybe it's time to take your broker off your speed dial. Calling up a full-service broker to execute a sell of 100 shares at $50, for example, can cost you a couple hundred dollars. Executing that same trade online will set you back only $10 to $50.
8. Scattering retirement accounts. Do you know where all your retirement accounts are? It sounds like an easy question, but if you've switched jobs during your career the answer may not be as simple.
When you change to a new employer, you have the option of leaving your old 401(k) where it is if you have more than $5,000 saved. This isn't a bad option, at least temporarily, if you're satisfied with the plan's performance or if you're unsure about what to do with the money right away. Eventually, however, you should move it. It's easy for you to lose track of an old plan -- and for its administrators to lose track of you. "Companies can go bankrupt or disappear as the result of a merger," says Rick Meigs, president of the 401(k) Help Center. "If your investments perform poorly and the account balance drops below $5,000, you could be cashed out of the plan. And you won't know about it till you see a check in your mailbox." Besides, with scattered accounts, it can be more difficult to keep a clear picture of your overall strategy and progress, and to avoid overlap and unbalanced allocations.
Rolling over money into a new 401(k) or IRA is a simple alternative that will give you the discipline to continue saving for retirement. For more on the rules of rolling over your accounts, see Smoothing the Road for Retiree Rollovers.
9. Buying or selling on emotion. If you invest directly in stocks, one of the toughest concepts you'll ever grapple with is when to buy or sell. You may tend to buy on impulse or hang on to a dud for too long.
The trick is to take the emotion out of the equation. Before buying a stock, get to know the company first. Does the business and its financials make sense? Is the company growing? Are you paying a good price? (Use Kiplinger's Stock Finder to research answers to these questions.) Write down your reasons for the purchase, and check at least once per quarter to make sure your rationale still holds true. Then, as long as you own the stock, invest a set amount on a regular basis whether it's rising or falling. This strategy, known as dollar-cost averaging, helps you avoid timing the market and could net you more shares at a cheaper price over time.
To trim your losses on a falling stock, the easiest strategy is to put it on autopilot. Issue a limit order with your broker to automatically sell the stock if it reaches a designated price. See Learning to Say Sell for more tips on knowing when to cut loose.
10. Dragging your feet. If you've been putting off getting started in investing, consider this: each day that passes is money lost. For example, if a 30-year-old invested $5,000 and earned a 10% annual return, she'd have about $140,500 by age 65 if she didn't make any more contributions. If she had postponed that initial investment by just three years, she would turn 65 with a balance 25% smaller. The earlier you begin, the more your savings will grow as interest compounds.
If you're intimidated or overwhelmed and don't know where to start, read Build a Strong Stock Portfolio and Grow a Fund Portfolio for clear, concise explanations of how things work. Then use Kiplinger's Stock Finder or Fund Finder to track down the best investments for your criteria. Or, simply check out our pre-assembled fund portfolios for specific funds and allocations to reach your goals. You'll be up and running in no time.
If you think you don't have enough money to invest, think again. Starting small is better than not starting at all. Most funds carry initial minimum investments of $1,000 to $5,000, and you can use Fund Finder to search for those that allow you to start with less. Funds usually carry lower minimums for IRA accounts if you want to start saving tax-free for retirement.
Another option is exchange-traded funds. They are cheaper than traditional funds and they trade like stocks, so you can buy as many -- or as few -- shares as you want. (See our sample ETF portfolios for ideas.) To invest in ETFs or other stocks, try one of these brokers that let you start small. | 
GETTING STARTED