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The Five Key Investment Categories

December 2009

Bond Certificate

It is perfectly possible to create a portfolio with funds in just a handful of categories: The key to maximizing returns while minimizing risk is portfolio diversification—investing money in assets that are truly different from one another for fundamental reasons. When two investments are truly different from one another their prices will rise and fall out of sync, and sometimes even opposite to one another.

So, what are the key fund categories?

  1. A large US company stock fund, preferably one that focuses on nice steadily rising dividends. Dividends are what make stocks special. Stock holders are part owners and are entitled to a share of the company’s profits in the form of dividends; as the company grows, its dividends will generally rise too. Just make sure that you are paying a sufficiently low mutual fund expense fee so that most of the dividends are left for you.
  2. A broad bond fund or (better) individual bonds: What makes bonds special is that they provide a fixed, guaranteed rate of return and a guaranteed return of principal. Even in the event of a bankruptcy, bondholders will generally get a little something, while stockholders will be wiped out. Having this extra measure of safety for part of your portfolio has a stabilizing effect, giving you at least some positive return in tough times. Historically, having as much as 35 to 40 percent of your long-term portfolio invested in high quality corporate and government bonds can reduce the risk of major loss in any one year without sacrificing too much potential gain. Bonds are especially useful if it is likely that some of one's long-term savings might be needed within ten years or less. It can also make sense to add a couple of more specialized bond funds, such as a global bond or a “junk” bond fund, but be aware that these funds are more speculative and often behave more like stock funds than bond funds.
  3. A broad international company stock fund. Adding some international stocks to your portfolio can sometimes (but not always) help smooth the ride and provide extra growth. Many of the most familiar and best companies out there are headquartered overseas (for example, Toyota or Nestle). How are international stocks different? International company stocks are often affected by currency swings in ways that are different from US companies. Local regulation and taxation may be more favorable overseas than it is in the US. In addition, many new or emerging economies, such as India or Brazil, may grow faster than the US, so it is good if your international fund can invest in these regions. Just be careful—too much international exposure can make your portfolio more volatile .
  4. A small- to mid-sized company stock fund(s). Small may not always be better, but in the world of corporations small is clearly different. It’s easier to grow a small company than a large company. Much breakthrough innovation takes place in small, entrepreneurial companies. Large companies love to buy small companies, adding to your investment gains. On the other hand, small companies often struggle in bad economies. Many depend on just one product or service and can be vulnerable to competition, so a little bit of little company stock can go a long way. While the US has been a particularly happy place to start a business, providing lots of room to grow and explore new markets, Europe and Asia are now catching up as incubators for innovative and entrepreneurial companies, so it can be good to add an international small company fund or to make sure your small company fund can invest overseas.
  5.  Cash. Yes, unloved, low-return, super-boring cash. There in an emergency. Downright profitable when interest rates spike. Ready when opportunity strikes. Useful even in retirement accounts. Don’t leave home without it.

The latest data (as of year end 2008) showed that, once again, over 75 percent of mutual fund managers underperformed the market averages, so it pays to look for good cheap index funds when putting together your portfolio. If you can't find a good cheap index fund in a particular category, look for the cheapest, lowest turnover, actively managed fund.

Our advanced course on Exchange Traded Funds can help you put together a simple low-cost portfolio that leaves more dividends, interest income and market gains for you. Sign up now.


The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Outside sources used in this article are believed but not guaranteed to be accurate. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.