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Money Matters For all the talk about zigs and zags in our last edition of Money Matters, you'd be forgiven for thinking it was a sewing column. Well, in a way it was, as we're now at the point to think about stitching together a long-term investment portfolio. The fabric for our portfolio is supplied by "asset classes" -- groups of securities representing distinct investment styles. The word "distinct" is important here. To be useful in our portfolio patchwork, the asset classes need to be different from one another -- "poorly correlated" in financialspeak. The easiest way to build a portfolio is to a find a number of mutual funds or exchange-traded funds, each maintaining constant exposure to its asset class by mimicking a benchmark index. Mutual fund? Exchange-traded fund? Index? The terminology's coming hot and heavy now. Not to worry, though. These aren't difficult notions. A mutual fund investment represents shares in the stock of a company whose sole asset is a portfolio of securities or some other property. By owning shares in the company, you take a proportionate interest in the gains, losses, and income generated by the underlying portfolio. The selection of the stocks or bonds that make up the portfolio, and the timing of their purchase and sale, is left to a professional investment manager hired by the fund company. The manager's compensation, along with all of the fund's other expenses, comes out of the portfolio's assets. Each mutual fund has an investment objective -- a flavor, so to speak. Those funds that give the manager wide berth to strive for the objective allow "active" management. Actively managed funds can veer and careen over investment style boundaries between quarterly reports as the manager looks for profitable opportunities. Some funds, however, set strict adherence to market benchmarks as the investment objective. These so-called "index funds," in essence, give their managers a shopping list of securities to put in portfolio. A fund dedicated to tracking the S&P 500 index, for example, obliges the manager to build and maintain a portfolio mirroring the components and weightings of Standard & Poor's 500-stock roster of large blue-chip companies. No veering and careening for index or "passive" investment managers. Each asset class has an index that serves as a target for investment managers and funds dwelling in that space. Active managers try to produce returns that exceed that produced by the class benchmark. Note that word "try." It's a rare manager who can consistently outperform the market, try as he or she might. Index funds and their managers take a different tack. Recognizing the difficulty in beating the market, they attempt instead to meet the market. That's advantageous for investors building portfolios. Investors need reliable exposure to asset class benchmarks to keep their programs properly balanced. An added benefit of index funds is their low cost. Without having to invest time and capital in researching investment choices, index fund management costs are lower than those of actively managed portfolios. A well-diversified portfolio can be created with no more than a half-dozen funds benchmarked to indexes representing these classes:
In upcoming columns, we'll look at investment options within each class and a tool that will help you allocate them inside your own portfolio. In the meantime, if you have any questions on investments, feel free to e-mail them to financewriter-asja@yahoo.com Brad Zigler, in a former life, headed up marketing, research and education for a securities exchange and for an investment management firm. He now writes and edits for a number of financial publications and is a brand-new ASJA member.
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