DIY: Building Your Very Own Investment Portfolio
The more boring the investment, the better; at least, that's my core investment philosophy. Investing to generate long-term wealth does not have to be complicated, and anyone that tries to tell you otherwise may not be looking out for your best interest. Over a long time frame, the only proven way to beat the market is to take more risk and lower your fees, but you have to understand your volatility and risk horizon by doing so. So consider the risks before investing in that next trend or meme stock. It’s never too late to simplify and streamline your investment holdings. As for which particular funds are the best for you, it’s very difficult for anyone to flat out tell you--“this is the best for you, just take my word for it” without a proper analysis of your specific financial circumstances and risk tolerance. With that said, I hope you find the investment portfolio suggestions easy to follow and understand. I would be happy to confirm or adjust these suggestions based on your specific circumstances if you take the time to schedule a call.
I've spent the last decade studying the financial markets and being part of an industry that encourages investors to hire a financial advisor to guide them with investment management. I love helping to teach families how to control their investments with a few simple, easy to understand and easy-to-manage strategies. The steps outlined in this article will show you how to get it done the right way without hiring anyone (yep - that includes me). Again, my reasoning here is that I genuinely believe that investment management is something that you can teach yourself and manage with proper guidance.
I believe the best portfolio for the average investor isn't some complicated trading strategy or a mix of high-cost actively managed mutual funds. Rather, it's simply buying and holding a diversified mix of low-cost index funds. I especially like the three-fund portfolio that John Bogle invented and pioneered for many decades. Einstein famously said, "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." I agree wholeheartedly. The potential for compounding interest over time is what makes owning these simple index portfolios so appealing. So here are my recommendations for getting started.
The One Fund Portfolio: Domestic Stocks
Legendary investor Warren Buffett has repeatedly written that the average investor should invest their money in an S&P 500 index fund. The S&P 500 is composed of the 500+ largest publicly traded U.S. companies. You can invest in the S&P 500 at Vanguard with the Vanguard 500 Index Fund (VFIAX, expense ratio = 0.04%) or the exchange-traded fund Vanguard S&P 500 ETF (VOO, expense ratio = 0.03%). By investing in the S&P 500, you will get the market return that most investors try (and typically fail) to beat.
COUNTERPART to the Vanguard funds is the Fidelity 500 Index Fund (FXAIX, expense ratio = 0.015%).
Before naming a few other funds, I would like to give you a little more background as to why many of these portfolio examples are Vanguard funds. Vanguard is the largest index fund manager in the world. While there are other excellent index funds (Fidelity and Schwab being the most popular) with low expense ratios, Vanguard remains the gold standard in the index fund management world. So to keep things simple, I will be choosing mutual funds or exchange-traded funds from Vanguard, and I will also give you a counterpart option with Fidelity to keep things even.
Since the S&P 500 index only contains large-cap stocks, I, along with most of the F.I.R.E. community, prefer the Vanguard Total Stock Market Index Fund (VTSAX, expense ratio = 0.04%) or Vanguard Total Stock Market ETF (VTI, expense ratio = 0.03%), because it gives you ownership of small-cap and mid-cap stocks in addition to large-cap stocks. By investing in more than 3,500 stocks, the Vanguard Total Stock Market Index fund provides a more diversified portfolio than the S&P 500 portfolio and therefore is my favorite domestic stock fund.
COUNTERPART (Fidelity Total Market Index Fund; FSKAX, expense ratio = 0.015% OR the newer Fidelity ZERO Total Market Index Fund; FZROX, expense ratio = 0.00%).
The Two-Fund Portfolio: Domestic Bonds
For many investors, especially young investors, the one-fund portfolio is all you need. But since domestic stocks are volatile, most investors will want to add some bonds to their portfolio to lower their risk profile. Bonds are much less volatile than stocks, and they often move in opposite directions as stocks (including during the 2008 financial crisis). The Vanguard Total Bond Market Index Fund (VBTLX, expense ratio = 0.05%) or Vanguard Total Bond Market ETF (BND expense ratio = 0.04%) is a great way to purchase a broad spectrum of the domestic bond market. By investing in over 8,500 corporate and government bonds, this index fund gives you a broad, diversified portfolio of U.S. bonds.
COUNTERPART (Fidelity US Bond Index Fund; FXNAX, expense ratio = 0.025%).
The Three-Fund Portfolio: International Stocks
With just two funds, you have now invested in the entire U.S. economy. Just those two funds alone are an excellent portfolio for many investors. But since the U.S. economy is only a fraction of the global economy, you can increase diversification by adding an international stock market index fund. The Vanguard Total International Stock Index Admiral Shares (VTIAX, expense ratio = 0.11%) or Vanguard Total International Stock ETF (VXUS, expense ratio = 0.09%) give you broad exposure to both developed international stock markets (such as Europe and Japan) as well as emerging markets (such as Latin America, Russia, and China).
COUNTERPART (Fidelity Total Intl Index Fund; FTIHX, expense ratio = 0.06%).
Four-Fund Portfolio: Add International Bonds
The three-fund portfolio is a very popular portfolio. I don't purchase any additional asset classes beyond domestic stocks, international stocks, and U.S. bonds. However, some investors may be interested in additional diversification.
The next type of fund I would add to your portfolio includes international bonds. International bonds will not move in lock-step with the U.S. bond market, so you can increase the diversification of your portfolio by adding t the Vanguard Total International Bond Index Fund (VTABX, expense ratio = 0.11%) or Vanguard Total International Bond ETF (BNDX, expense ratio = 0.08%) are excellent low-cost ways to get exposure to the international bond market. It contains over 4,200 international bonds, including bonds from foreign governments and international corporations. The index contains bonds from both developed and emerging markets.
COUNTERPART (Fidelity International Bond Index Fund; FBIIX, expense ratio = 0.06%).
Five-Fund Portfolio: Add R.E.I.T.s
With a four-fund portfolio, you now have exposure to the entire global stock and bond market. If purchased in the correct proportions, you can replicate Vanguard's Target Retirement Funds. Creating your portfolio this way will be cheaper than buying the Target Retirement Fund directly from Vanguard.
However, there are alternative asset classes that don't move with either the stock or bond markets. Because of their low correlation to stocks or bonds, adding these alternative asset classes can further increase the diversification of your portfolio.
The most popular alternative asset class is real estate. You can invest in real estate by purchasing rental properties, which is what we do personally. However, for investors that don't want to invest in physical real estate directly, you can get real estate market exposure with the e Vanguard R.E.I.T. Index Fund (VGSLX, expense ratio = 0.12%) or Vanguard REIT ETF (VNQ, expense ratio = 0.12%).
COUNTERPART (Fidelity Real Estate Index Fund; FSRNX, expense ratio = 0.07%).
Summary
To recap, here are the five portfolios in order of complexity.
One-Fund: Start with Domestic Stocks (S&P 500):
VFIAX or VOO
COUNTERPART: Fidelity 500 Index Fund (FXAIX)
One-Fund: Start with Domestic Stocks (Total Stock Market):
VTSAX or VTI
COUNTERPART: Fidelity Total Market Index Fund (FSKAX) OR Fidelity ZERO Total Market Index Fund (FZROX)
Two-Fund: Add U.S. Bonds:
VBTLX or BND
COUNTERPART: Fidelity US Bond Index Fund (FXNAX)
Three-Fund: Add International Stocks:
VTIAX or VXUS
COUNTERPART: Fidelity Total Intl Index Fund (FTIHX)
Four-Fund: Add International Bonds:
VTABX or BNDX
COUNTERPART: Fidelity International Bond Index Fund (FBIIX)
Five-Fund: Add Real Estate Investment Trusts:
VGSLX or VNQ
COUNTERPART: Fidelity Real Estate Index Fund (FSRNX)
For more due diligence and all the information you need, please visit the Vanguard Target Retirement Fund website:
https://investor.vanguard.com/mutual-funds/target-retirement/#/
You can select the years to retirement or the years that you will need access to the funds you want to invest. For example, assuming that you need access to the funds in 10 years or that you are looking to retire around the year 2030, you can review the Vanguard Target Retirement 2030 Fund (VTHRX). You can scroll down to the bottom of the page and review the portfolio composition, or the allocation of the underlying funds within this mutual fund account. As of 06/30/2021, the allocation of the Vanguard Target Retirement 2030 Fund (VTHRX) is:
Vanguard Total Stock Market Index Fund Investor Shares 39.60%
Vanguard Total International Stock Index Fund Investor Shares 26.60%
Vanguard Total Bond Market II Index Fund Investor Shares 23.50%
Vanguard Total International Bond Index Fund Investor Shares 10.00%
Vanguard Total International Bond II Index Fund 0.30%
That's how you create a diversified index fund portfolio using Vanguard or Fidelity mutual funds. The most crucial part is allocating these funds based on your risk tolerance and time horizon. As we discussed, you can start with the Vanguard Total Stock Market Index and gradually add funds as you read and learn more about investing. You don't need to have a degree in finance or Wall Street trading experience to do this. With any of the portfolios I described above, you'll likely beat most fund managers on Wall Street. What do you think? Do you plan on using Vanguard or Fidelity funds in your portfolio?
