Building a Simple Investment Portfolio

Remember the first time you had to make your 401k selections? Perhaps you are a student or new graduate so you haven’t had to pick your retirement funds yet (it’s coming). Constructing a retirement portfolio is foreign to most of us because our parents didn’t talk about it and we spent our late teens/early twenties in college or building a small business. The “ins and outs” of investing and retirement planning is not an innate skill. I remember the first time I had to select my 401k investments from a list provided by the HR department. Glancing over the list I saw over 30 fund names that I could select but I had no idea what any of the funds actually did. I literally had never heard of the funds.

Building a portfolio of investments can be a daunting task for seasoned investors and beginners alike. Professional money managers and financial advisors have an abundance of information at their disposal to build and maintain investment portfolios to maximize returns. Us regular retail investors don’t have the time or knowledge/skill to construct a portfolio so we typically rely on a financial advisor to manage the portfolio, invest in actively managed mutual funds or purchase passive index funds. However, simply paying someone else to manage your portfolio (i.e. financial advisors and actively managed mutual funds) is not guaranteed to beat the market. In fact, CNBC found that the majority of large-cap funds managed by professionals often fail to match the overarching index (Dow Jones, S&P 500, etc).  Put another way, the people you hire to make financial decisions are performing worse than not hiring anyone at all.

Enter a simple approach to building an investment portfolio. There are probably thousands of different ways to make stock market investing easy, however I found three general methods used most often. Target-date funds, three-fund portfolio, and the total stock market fund approach represent three ways to construct a very simple, passive investment portfolio. 

Target-Date Fund 

Target-date funds are the ultimate “set it and forget it” fund and are used most often by beginner investors. Specially, target-date funds are mutual funds or ETFs that are structured in a way to hold the best assets within the fund based on a specific anticipated retirement date. The mix of assets within the fund are managed so they align with the “wealth accumulation” and “wealth preservation” phases of a career. The funds are automatically rebalanced along the way and the mix of funds will change each year…typically more aggressive in the early years and more conservative in the later years. 

Advantages – The “mix” of investment is managed by the fund goals, rebalancing is automatic, autopilot investing, all-in one fund, diversified without having to think too much (just pick a retirement date)

Disadvantages – No control over the underlying funds or investments, expense ratios can be high, income is not guaranteed, very rigid

Three-Fund Portfolio

The Three-Fund Portfolio was made popular by John Bogle (founder of Vanguard and investing icon) and by his followers who are aptly called the Bogleheads. John Bogle used to say “the majesty of simplicity” is the basis for his approach to investing. The Three-Fund Portfolio typically contains a (1) total stock market fund, (2) total international stock index fund, and (3) total bond fund. The percentage of each fund depends on the investor’s timeframe for retirement. The investor simply selects the funds (depending on their brokerage) to make up the three funds. 

Advantages – Diversification, very low costs, tax-efficiency, removal of manager risk (i.e. financial advisor or fund manager making mistakes), no overlap of funds and underlying companies

Disadvantages – Limited exposure to high growth funds, requires the investor to rebalance periodically, might not be appropriate for investors at certain times (i.e., bonds are not typically needed at a young age)