One of the things I was taught when learning to fly a small plane is that the plane’s design and aerodynamics do most of the work. The pilot needs to make only small adjustments and inputs to keep flying smoothly and on course. There are many activities in which the less work you do, the easier and more productive the activity is. Investing is such an activity, and that is the philosophy behind our Core Portfolios.
I sometimes refer to these as our Armchair Portfolios, because they don’t require a lot of work. We carefully set up diversified, balanced portfolios using mutual funds that are consistently successful. Then we let the markets and their inevitable compounding of wealth do the rest of the work. Our only adjustments are to rebalance the portfolio once or so a year, and to change a fund when circumstances require it.
Studies consistently show that investors in load funds (those with sales charges) earn higher returns than do no load investors. That is not because the load funds earn higher returns. It is because the load fund investors are hesitant to switch their investments once a sales charge has been incurred. After a solid long-term fund is selected, they are likely to leave the money in place and let the market take over. Other investors have a tendency to over-trade. When a good fund has a disappointing quarter or two, they are quick to switch into another fund. Usually they sell a fund at the bottom of its cycle and buy another at its top. That’s not a good formula for increasing wealth.
The Dull Investor also saves money on taxes and other expenses. Outside of a tax-deferred account, every sale of a fund at a profit results in taxes. Your new fund has to do better than the old fund to justify the switch. Plus, it has to make up for the tax bite from the sale. The new fund also has to make up for any commissions or other trading costs. There aren’t too many investors who can time their trading that well.
For example, after the Asian currencies and stock markets fell apart in late 1998, I heard from some readers who wanted to sell their Core Portfolio positions in Price New Asia. At that time the fund was down about 70% over the prior 12 months. I counseled holding this long-term position and watching the recovery. Those who followed my advice saw the fund more than recover its losses in about 12 months. The only way to get better results than holding for the long term would have been to sell New Asia and buy the right technology stock funds. Anyone who sold and purchased a more conservative U.S. fund still is waiting to get back most of the loss.
Parts of the Core Portfolio will fall at times, while others rise. But over time, the entire portfolio will steadily increase. That’s been the experience of our Core Portfolios. The Core Sector Portfolio has had a steady increase of over 15% annually since 1991. That meets our goal of doubling our money every four to six years.
In the Core Portfolio I like primarily value stock funds. In the last 10 years, growth stocks have been the big winners. But that is unusual. The only decades in which growth stocks beat value stocks were the 1920s, 1930s, and 1990s. The best value funds give you strong, steady appreciation in good times and lose much less of their value in bad times. I prefer to save growth stocks for the Managed Portfolio. We can buy them after one of their periodic sharp declines and sell them after a big run up, as we just did.
Except for the value stock preference, the Core Portfolios tend to be balanced and diversified.
The heart of the Core Portfolio captures a major portion of the U.S. stock market. You can accomplish this with an index fund, such as Vanguard Total Stock Market or another fund that tracks either the Russell 3000 or the Wilshire Total Market indexes. I prefer to use American Century Income & Growth. This fund starts with the 1,500 largest stocks in the U.S. market and uses a computer model to weed out the stocks that are most overvalued or that have other characteristics indicating below-average future performance. The model has done a good job. Until the last couple of years the fund beat the S&P 500. Now it is a fraction behind the index. But that will change as the market favors highly-valued growth stocks less than in the recent past.
Then add some small stock funds that seem to do well in all kinds of markets, rather than those that do well only when small stocks are doing well. I’ve recommended Acorn USA in the Core Portfolios. You also would do well with the original Acorn Fund or funds from the Baron family, such as Baron Asset and Baron Small Cap.
You need international stocks to have a diversified portfolio. We invest in the major international markets through the conservative, solid Tweedy, Browne Global Value. I also recommend a small investment in the emerging markets through Scudder Latin America and Price New Asia. Though these markets are volatile, in the long run you’ll be glad of the high returns that these two funds will generate. I believe these funds are the best vehicles in these markets.
You should have some real estate in a long-term portfolio, and I believe real estate investment trusts through Cohen & Steers Realty Shares are the best way to own real estate as I discussed earlier in this visit. The high dividends plus appreciation of the properties provide a good base for the portfolio, and it just might return more than the U.S. stock market indexes the next few years.
Intermediate treasury bonds round out the Core Sector Portfolio. I prefer intermediate bonds, because historically they generate a higher total return than either long-term or short-term bonds. An alternative is a bond index fund.
In the Core Balanced Portfolio we add high yield bonds. Northeast Investors Trust is a flexible fund that for over 30 years has done a great job finding bargains that pay high yields and will score large capital gains. When interest rates rise or a credit crunch appears, the fund has a rough patch. But that often is followed by a gain of 20% or more, and the fund handily beats the average high yield bond fund.
Rounding out the Balanced Portfolio is Vanguard High-Yield Corporate. Many investors are scared of high yield bonds. But this fund is very conservative. It rarely loses money, holds up well in bad markets, and captures a nice yield for the portfolio. That provides a boost to total returns, especially when the stock market is down.
You need to decide how much of your total portfolio should be Core. Some subscribers don’t want to spend much time on their investments, so their entire portfolios are Core Portfolios. But if you want to spend on your investments, want to be more active, or want to shoot for higher returns, you increase the size of your Managed Portfolio that I update in each visit. You might want to use the nation’s pension funds as a guide. Most have from 10% to 50% in a Managed Portfolio.
If you are a new subscriber, I recommend setting up your Core Portfolio first. You could make your whole portfolio a Core. Then over time you can move parts of it to develop a Managed Portfolio that takes advantage of the market cycles and investor over-reactions.
My recommended allocations each month include a “Blended Portfolio” that assumes your total portfolio is half Core and half Managed. That makes the calculations easier for you.
Once your Core Portfolio is set up, sit back, put your feet up, and let the markets and our fund managers do the work of steadily increasing your wealth over time.