Designing Your Investment Portfolio

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designing your investment portfolio
As a Green Wealth Belt holder, you probably have less than $75,000 saved up. That includes the combined total in your company sponsored 401(k) or other retirement plan, IRAs, stocks, stand-alone mutual funds, cash, etc. While that’s a nice chunk of money, it’s not really enough to justify spreading your money into lots of different types of investments. There are plenty of easy to understand investments that can keep your portfolio well-diversified and growing.

Green Wealth Belt (GWB)
Jumpstart Training Mini-Course

  1. Green Wealth Belt: Introduction
  2. Types of Investment Options & Investment Accounts
  3. Determine Your Investment Risk Tolerance Level
  4. Designing Your Investment Portfolio
  5. How to Accelerate Wealth Creation & Conclusion

 

In my opinion, the wisest investments for the vast majority of your portfolio right now are mutual funds that consist of stocks, bonds, and money market instruments. However, bonds and money markets are generally safe enough that you could purchase them as stand-alone investments.

As I mentioned in the prior article, the mix of these will depend on your risk tolerance level. Stocks are the riskiest, followed by bonds and then money markets.

Mutual Fund Styles

In a moment, I’ll share some portfolio and money management strategies, but I need to delve a bit deeper into the world of mutual funds so that you can make good decisions. Here are six mutual fund styles that would be apply to a Green Wealth Belt holder:

Aggressive Growth – This means that the stocks in this fund are highly volatile. There’s great potential to make a lot of money as well as lose it. This is as risky as a mutual fund can get. They tend to perform well when the economy is booming and not as well during hard times. Typically, someone nearing retirement age would not have much of this in their portfolio, but a very young person would.

Growth– These types of funds are comprised of stock from companies that are growing and expending rapidly. The money that these companies make might be used to buy other companies, build faculties, etc. So the profits are reinvested rather than paid out as dividends to stockholders. These funds still carry a high degree of risk.

Growth & Income – These types of mutual funds attempt to strike a balance. On one hand, it includes new companies that are growing rapidly, but pay no dividends. On the other hand, it pulls in growing companies that pay dividends. It may also include bonds or other securities that pay interest.  This is typically a favorite mutual fund among people with a moderate level of risk tolerance.

Hybrid – Mutual funds that carry this label will consist of a combination of stocks and bonds.  Depending on the condition of the economy, the fund manager could have a larger percentage of one or the other. Typically, investors who have moderate to conservative risk tolerances like to have these in their portfolio.

International – These funds consist of stocks from companies who are outside of the United States. This is different from “Global” funds, which refers to the whole world including the United States.  International mutual funds can span the gamut as far as risk tolerance. But typically they lean toward the aggressive to moderate side of the spectrum.

Fixed Income – These types of mutual funds are the least risky. They are comprised of bonds and Certificates of Deposit (CDs). While they are very safe, the return on your investment will likely be very low. Typically, investors who are retired, near retirement, or have a low risk tolerance will have a little or a lot of this in their portfolio.

Index – You may have heard names like the S&P 500, Russell 2000, Nasdaq 100, Wilshire 5000, etc. These are indexes. They are comprised of a basket of stocks that represent a portion or all of the stock market.  For example, the Wilshire 5000 index consists of the stocks for all companies in the stock market. And the S&P 500 consists of the stocks of 500 leading companies.

These large and well-diversified indexes provide a general snapshot of how the stock market is performing overall   Hence, their goal is not to beat the market, like other mutual funds try to do, because they primarily serve as market benchmarks. So, the goal of other mutual funds is to beat the performance of these indexes.

Believe it or not, some of the research has shown that large-cap mutual funds that employ so-called genius fund managers to run them have beaten the index funds less than 20% of the time, historically. The index funds don’t require all that fancy stock-picking expertise because they are what they’ve been for decades. So if you’re a moderate to conservative investor, an index mutual fund may be a good option for you.

So there you have it, six major mutual fund categories that I think could easily make up all (or nearly all) of your investment and retirement portfolio. There are more categories in the marketplace, but I don’t want to muddy the water here. If you’d like to know more about them, just peek at the Brown Wealth Belt mini-course. Again, I decided to limit the discussion to these six because of the size of your portfolio.

Under these categories, there are thousands of mutual funds to choose from. Of course, I understand that you may decide to invest in a stand-alone stock, bond, or money market instrument for whatever reason. That’s fine. But if it were me, I’d have at least 80% of my portfolio invested in mutual funds.

Market Capitalization

Ok, ok….before your eyes start to glaze over, don’t worry, I’m not going to get all technical on you. The term “market capitalization” simply refers to the size of a company and it can play a key role in your mutual funds selection criteria.

In the stock market world, companies are divided into small, medium, and large. So you’ll often hear the terms small cap, mid cap, and large cap. Of course, “cap” stands for capitalization. A company’s capitalization is really determined by simple math. It’s their current stock price per share multiplied by the total number of outstanding shares.  So if see that a company’s stock is selling for $10 per share and they have 10,000,000 shares outstanding, that brings their capitalization (or size) to $100,000,000. Here’s a breakdown of capitalization categories:

Small cap – The company’s size falls in the range of $300 million to $2 billion. These are usually new or young companies that are seeking to make their presence felt.  Their stock will generally be riskier than that of mid cap companies.

Mid cap – The company’s size falls in the range of $2 billion to $10 billion. Many growth companies fall into this category.  They are the strong up and comers, but have stocks that are riskier and stock prices that more volatile (up and down) than large cap companies.

Large cap – The company’s size falls in the range of $10 billion to $200 billion. These are the giant name brand companies that you’re most familiar with, such as Coca Cola, Microsoft, etc. They are generally considered as stable and secure.

So what does this mean from an investing standpoint? Well, historically speaking, over the long haul, companies that are in growth mode have delivered higher returns than the super big guys. Now, this is not the case in every era because big companies have had periods of great performance.

This is just information you should keep in the back of your mind as you evaluate mutual funds and the types of companies they’ve chosen for their portfolio. So I’m not suggesting that you take every cent you have and invest it in small and mid cap companies.

Your Investment Strategy

In designing your investment portfolio and implementing a strategy, you have to first step back and consider every aspect of your life that will require money and when that money will be needed. You may need to save money for a home, car, retirement, etc.

Depending on your goals, a multi-pronged strategy may be in order. Time and taxes are key factors that will influence your decision. For example, you could contribute to a particular mutual fund that is available through your company’s 401(k) retirement plan. But if you withdraw any of that money early, you’ll be subject to income taxes and a stiff penalty.

At the same, you could open a regular investment account at a brokerage firm such as E*Trade and purchase shares of the same mutual fund. When you withdraw money is this instance, you would pay taxes on just the profits, but there would be no penalty. Plus you’d be able to get this money within 24-48 hours as opposed to jumping through hoops to extract money from your 401(k).

What this means is that your portfolio should be structured to meet both short-term and long-term objectives, as well as potential emergency situations.

As a Green Wealth Belt holder, my thinking is that you should have enough money saved such that (if you wanted to) you could pay off all your medium-terms debts (under 5 years left) in full and still have $15,000 left over. This excludes the debt on your home.

In addition, at least 50% of the money you have available to pay off debts should not be tied up in investments (such as a 401k) that would trigger early-withdrawal penalties by the IRS if you requested those funds. Again, this is my opinion based on my life experience and belief.

Choosing Your Investments Smartly

Before you choose a particular mutual fund, be sure to do your research. Read the fund’s prospectus that outlines the mission and goals of the fund, and the types of investments it buys into.  In addition, review the fund’s performance (% rate of return) over the last 1,3, and 5 years. I think that 3 years is the sweet spot, but take all periods into account. The prospectus will contain this information,

Finally, compare the fund’s performance with any of the major stock indexes such as the S&P 500 or the Wilshire 5000 over the same timeframes. Think of an index’s performance as what you dog could generate it you let it invest your money.

So, if a fund can’t beat the rate of return of a standard index, skip it. In fact, before making any investment decision or hiring a financial advisor, who touts they can work miracles with your money, always use the indexes to establish the minimum acceptable rate of return on your investment.

Investment Portfolio Models

Now that you have some sense of the broader strategy, let’s try to narrow the discussion to deal with your specific financial situation.

Earlier in this course, you determined your risk tolerance level. The three levels are: High (Aggressive), Medium (Moderate), or Low (Conservative).  The next step is to match your risk level with the corresponding mutual fund styles (discussed at the beginning of this article) and other investments.

In my research, I’ve discovered varying opinions for what would constitute a good mix of investments for each risk tolerance level. As shown in the diagrams below, I’ve tried to make it as simple as possible. The percentages aren’t absolutes and you can adjust them slightly in one direction or the other. But they will give you a good idea of the direction you should be headed in.

Although not written in stone, most financial advisors will tie your risk level to your age.

Aggressive Investors – Should be those in their 20’s and 30’s
Moderate Investors – Should be those in their 40s and 50’s
Conservative Investors – Should be those in their 60’s and above

The reason given to a 25 year old for taking greater investment risks is because they will have a longer period of time to recover from multiple economic downturns over their lives. Plus there’s the compounding effect of watching your money double, triple, and quadruple over time. On the other hand, a 60 or 70 year old person may need a predictable stream of income to live on and don’t want to deal with wild swings in the stock market. But depending on your resources and personal situation, you could be more or less aggressive at any age.

As a rule of thumb, most of your portfolio should be in stock mutual funds, even if purchased through your company sponsored retirement plan, IRAs, etc.  And I know that some people will also have a very small percentage of stand-alone stocks, bonds, cash, etc, which is totally fine.  Just keep in mind that when you know you’re going to need money to for a major purchase in the near future, consider directing more of your savings to less volatile funds and increasing your cash on hand.

There’s no magic here, just guidelines. Your job is to keeping pumping in as much cash as you can.

investment portfolio models

Sometimes it can be a little tricky to determine if a mutual fund is Aggressive Growth, Growth & Income, etc. That’s because the mutual fund companies may not always use those words to describe the fund. For example, one company uses the phrase “capital appreciation” to describe its aggressive growth fund.

So you may have use a web site such as Morningstar.com to nail it down when the wording is fuzzy or visit the company’s web site that advertises the fund. Or, do my favorite which is to take thirty seconds to contact/call the mutual fund company directly and just ask what’s the style and objective of the fund. Don’t make it harder than it needs to be.

Regardless, you should read the prospectus (documentation) for the fund to make sure you’re getting exactly what you want. Don’t rely on a few snappy words.

Action Step:

  • Create an investment portfolio that matches your risk tolerance level. (Note: Remember that your portfolio will consist of cash and investments that are both inside and outside of investment accounts such as your 401k.)

>>>How to Accelerate Wealth Creation & Conclusion>>>

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