Portfolio 107: A simple portfolio

By Morningstar.com

A purple-gold sunset. A perfectly grilled hamburger. Laughter. The scent of a lily. Scratching an itch.

The simple things in life can bring great joy. And a simple investment portfolio can bring great profits.

Choosing investments doesn't have to be complicated. By estimating the cost of your investment goal, articulating your risk philosophy, building your emergency fund, establishing your asset allocation, and conceptualizing your core portfolio, you've already done the hard work.

Now, you merely need to select some core investments to get you where you need to go. Here's a simple way to do just that.

Mutual funds: The simple choice

Thanks to Portfolio Course 105: Determining your asset mix, you already know what your asset allocation ought to be among the three basic asset classes: stocks, bonds, and cash. You also know if your portfolio will have any small-company or foreign-stock assets. Now, you need to fill in the specifics by choosing actual investments.

Investors seeking simplicity should go directly to mutual funds. Do not pass go, do not collect $200, and do not buy stocks and bonds directly.

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Why? Funds generally require less monitoring than individual securities do. Further, funds are well diversified -- one fund can own hundreds of securities. As a result, they're less volatile than individual securities are.

Moreover, simplicity seekers should think only in terms of core holdings. As we explained in Portfolio 106: Core vs. noncore investments, all you really need are core holdings. The rest is often frills.

For your U.S. stock exposure, low-cost index funds can be a great choice. To kill two birds -- your large- and small-company U.S. stock exposure -- with one stone, choose a fund that invests in the entire U.S. stock market, such as Vanguard Total Stock Market (VTSMX, news, msgs).

For bonds, choose from among Morningstar.com's Fund Analyst Picks. (Note that Fund Analyst Picks are available only to Premium Members. But nonmembers can sign up for a free trial of Morningstar.com's Premium Service .) If you're in a high tax bracket, consider one of the municipal-bond fund picks. Focus on the options that favor high-quality intermediate-term bonds and carry low expenses -- no need to take on extra interest-rate or credit risk for a shot at a modestly higher return.

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If taxes aren't a concern, consider funds in government-bond categories or the general-bond categories. Focus on the low-cost, intermediate-term choices here, too.

For foreign stocks, consider Morningstar's foreign-stock category picks, such as those in the foreign large-blend category.

Build a simple portfolio

Now let's build a diverse yet simple portfolio using Morningstar.com's Instant X-Ray.

Michael has $10,000 to invest. He wants to retire in 35 years.

After tinkering with his asset mix, Michael decides that his asset allocation should be 0% bonds, 70% large-cap U.S. stocks, 10% small-cap U.S. stocks and 20% foreign stocks.

He decides to put $8,000 in Vanguard Total Stock Market VTSMX to cover the large- and small-cap allocations and $2,000 in American Funds EuroPacific Growth (AEPGX, news, msgs) to cover the foreign position.

You can enter Michael's portfolio into Morningstar.com's Instant X-Ray tool. After inserting the information, click "Show Instant X-Ray" at the bottom of the screen to see the results.

Given that Michael has more than 20 years until he draws on his portfolio, this mix looks good. It's diversified by investment style, with roughly three fourths of his assets in large-cap stocks and the rest in mid- and small-cap stocks. The portfolio isn't terribly overweight or underweight in a single sector, nor is it overexposed to one type of stock relative to the market.

Pretty simple, huh?

Published Oct. 1, 2008