We often fall into the trap of thinking that the simple things in life are, well, too simple. How can something simple be effective? This is a trap that is often apparent when building an investment portfolio. Investing seems like a mystery, and trying to maintain a properly diversified portfolio seems like it should be a complex operation.
The truth, though, is that investing doesn't have to be complicated, and sometimes a simple portfolio is the best option.
Benefits Of A Simple Portfolio
You might be surprised at the benefits associated with maintaining a simple portfolio. Here are some of the pros of keeping things simple when it comes to your investments:
- You are more likely to understand what you are investing in. The simpler things are, the better your understanding. Stay away from complicated products (like derivative swaps) that you don't understand, and stick with the assets you “get.” You make better decisions when you understand what you are dealing with, and that includes investments.
- There's less to manage. Just by virtue of the fact that you don't have to worry about keeping track of everything, a simple portfolio can be better for the beginning to intermediate investor. If you plan on managing your own portfolio, the simpler it is, the better off you are. Even if someone else is managing your portfolio, asking that it be kept simple can ensure that you understand what's happening — and you are less likely to end up the victim of a scam because simple often means greater transparency.
- Lower cost. Fees are a huge issue when it comes to investments. The more you pay in fees, the lower your real returns. Not only that, but you miss out on the compounding that the money would have experienced had it not been spent on fees. A simple portfolio, especially one composed of index mutual funds and ETFs, costs less than and you'll get a better bang for your buck.
Your simple portfolio has the potential to provide you with solid long-term gains. It's not going to result in dramatic profits, but it is likely to offer regular, steady growth over the long haul (short-term volatility is almost always a problem, no matter what you do).
How To Create A Simple Portfolio
Putting together a simple portfolio is, well, simple. First of all, decide what asset classes you want to include in your portfolio. Then, once you have an asset allocation figured out, you can purchase low-cost index funds or ETFs that fulfill that allocation. If you have $10,000 and want a portfolio that consists of 80% stocks, 10% bonds, and 10% real estate, things don't have to be complex. With this allocation, you would put $8,000 into stock funds, $1,000 into a bond fund, and $1,000 into something focusing on real estate, maybe a REIT (rather than a mutual fund).
If you pick an all-market or all-world fund, you don't need to worry about stock picking. You can add a little more diversity by perhaps dividing things up this way: $5,000 in a U.S. all-market fund, $2,000 in an all-world fund, and $1,000 in an emerging market fund. Then, you could divide your bond fund money into $800 to a Treasury bond fund and $200 to an emerging market bond fund. Finally, you could divide your REIT money into to two trusts, one domestic and one focusing on foreign property. Your dollar cost averaging efforts each month can split up your investments similarly.
At most, you end up with seven funds/trusts total. That's a pretty simple portfolio, and it can be effective.
Of course, you have to figure out what works for you, and do your own research. You might not want the same asset allocation as someone else. The important thing is to realize that you can make a simple portfolio, and it can work.