Developing a Core and a Non-Core in Your Portfolio

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Developing a Core and a Non-Core in Your Portfolio

For each goal you have identified for your investment portfolio, you might have a core group of three or four funds that you think can provide a level of returns over your investing time frame that will help you meet your goal. The bulk of your assets—typically 70% to 80%—could be invested in these core funds.

Core holdings are the engines

What are core holdings? They’re the engines of your portfolio, the investments that you think will help you meet your goal. Funds that fall into large-blend or large-value categories tend to be appropriate core investments for meeting long-term goals. For shorter-term goals, consider short-term or intermediate-term high-quality bond funds. Simplify the investing process by focusing on a few funds that you think can deliver what you want, and consider building your investment in those funds rather than adding other funds.

When looking for core funds, simple rules prevail. Typically, the more boring, the better; the goal is steady gains, not excitement. Look for funds with low fees, long-tenured managers, easily understandable strategies, moderate risk, and consistent performance.

Limit how much you put outside the core

Noncore holdings are the stop-and-go funds that may juice up returns—funds that focus on a single industry or emerging markets, and funds run by managers who make large bets on particular holdings or on certain parts of the market. Small-cap funds could also fall into this category, simply because they tend to be more volatile than large-cap funds. Use noncore funds for diversification and growth potential. For instance, if your portfolio’s core is made up of large-cap funds, you might want to add small-cap, international, or sector funds to the noncore portion of your portfolio for diversification. A variety of funds improves the likelihood of at least one of your investments doing well at a given time.

Though you probably wouldn’t want to put a significant portion of your portfolio in any one of these types of funds, they do allow for the possibility of excess returns. Of course, they also generally carry a higher level of risk. But as long as you limit the riskier portion of your portfolio, you aren’t likely to threaten the bulk of your nest egg. And for some people, core funds may be all they ever need.

Don’t worry about an optimal number of funds

There is no ideal number of funds to own. We have seen fund junkies build 30-fund portfolios while other investors can be perfectly diversified owning just two or three funds.

What you should worry about is how diversified your portfolio is, regardless of how many funds are in it. If all of your funds were growth funds or were heavy on a particular sector, you could own dozens of funds and still not be adequately diversified. Conversely, a one-fund portfolio could be better diversified than a multifund portfolio, if that one fund were an index fund covering the entire stock market.

Consider your tax situation

Are you investing in a tax-deferred account, such as an IRA or a 401(k)? If not, recognize that you’ll be paying taxes on any income and realized gains from your funds. And remember, funds can be tax nightmares. So if you are investing in a taxable account, look for funds (particularly tax-managed funds) that have the potential to generate strong aftertax results.