How many funds should I have in my portfolio?
Any idea how many funds do you need in your portfolio? No. You should. This is one of the most important questions investors need to address.
It should be easy. Spoiler alert: It isn’t.
In fact, it’s so complicated that we’ve had to break it down in to 8 separate topics:
- Money manager fees
- DIY investing
- Rebalancing
- Taxes
- Robo advisors
- Inactivity
- Psychology
- How many funds should I have in my portfolio?
Index
People have lots of reasons for saving money both long and short term. However, the magic of compound interest means those with a long time horizon, say greater than ten years, should seriously consider investing in the stock market using cheap index funds.
Yes, there have been crashes in the past, but major stock markets have nearly always recovered and then some. If your mum and dad had invested £15,000 pounds in the US stock market for you when you were born and you are 40 now you’d have way over a million pounds.
If you’re reading this, thinking that’s me, then congratulations, but if like many you haven’t really thought about future financial planning, now might be time to start thinking about investing.
Money manager fees
The easiest way to begin is to find somebody to do this for you. In fact, that is what many people do. Unfortunately, the fees financial professionals charge eat into your profits.
Often people get misled into thinking the fees they are paying aren’t expensive at all. They hear 1 or 2% and think that’s nothing.
However, here’s what Charles Schwab, the founder and Chairman of Charles Schwab Corporation (one of the first and biggest discount brokerages), had to say during an interview with Tony Robbins in Money Master the Game. “For every 1% over the lifetime of investing, it’s 20% of your money you’re giving up. Give up 2%, that’s 40%. Give up 3%, that’s 60%.”
Going it alone!
To avoid these hefty fees, lots of investors decide to go it alone. There’s a lot of convincing information out there promoting this idea that is hard to argue against.
A simple globally diversified portfolio of stocks and bonds, allocated according to an investor’s risk tolerance should provide the average investor with a strong investment portfolio.
These days you can put a cheap globally diversified portfolio together yourself. You just need a couple of exchange traded funds (ETFs). One ETF containing a basket of global stocks and the other containing bonds.
As stocks are a little riskier an investor divides between the two based on their risk tolerance and in many cases, age.
Young people with a pretty high tolerance to risk might have 80% stocks and 20% bonds. Older people with less tolerance to risk may have 20% stocks and 80% bonds. Lots of investors like to keep it as simple as possible with a 50/50 split.
Rebalancing your funds
Whichever is chosen rebalancing is usually recommended to ensure the correct allocation is maintained. Some rebalance monthly, some rebalance quarterly, but rebalancing annually should be sufficient for most investors.
These days this task shouldn’t take more than a couple of hours per year. For example, if you decided upon 50% stocks and 50% bonds, but stocks increased in value in a given year so much that your portfolio had 60% in stocks and 40% in bonds at the end of the year you would need to rebalance to get back to 50/50.
You could sell some of your stocks, or buy some bonds, or even do a bit of both to get the portfolio back to its original allocation. This process is great in that it requires you to sub consciously buy cheap and sell expensive.
As a result, all investors really need is a couple of funds and a couple of hours per year to rebalance. It couldn’t be simpler or could it?
US estate taxes
For those lucky investors over the pond it is. Americans can buy a single ETF that contains a diversified portfolio of stocks and bonds cheaply and easily. They don’t even need to think about rebalancing. The ETF does it automatically.
It’s possible that UK investors also have access to these by purchasing off US stock markets. However, it maybe wise for British expats to avoid buying ETFs off US stock markets. That is because there’s a chance such funds are liable for US estate taxes. That would be bad, because whoever inherits the investments may be liable for a big tax bill of up to 40%.
UK investors do have other similar options from companies like Vanguard and Blackrock. By my calculations, when you’ve added other fees such as upfront costs and broker fees you’re probably looking at total fees of around 0.5-1%.
That’s not too bad considering you don’t have to do anything except add money. You can choose a fund based on your risk tolerance and then just sit back and add money. Everything else is taken care of by the fund provider. It’s more or less set and forget.
Of course right now British expats are unlikely to be able to gain access to these funds, but it is worth keeping an eye on. Sooner or later some platform or another is going to allow expats to gain access to these excellent all in one products.
Robo-advisors
For British expats that would like a similar ‘set it and forget it option,’ Robo-Advisors might just offer a sensible alternative. These are becoming more and more popular by the day and for good reason too.
They use algorithms instead of people to provide you with investment advice and management for a fraction of the price of a real live money manager. Nutmeg costs start around 0.75% and Netwealth costs start around 1% and they are both available to British expats. Nutmeg is a little cheaper and requires a smaller initial investment, but Netwealth accepts British expats residing in countries that Nutmeg doesn’t.
Both of these would provide you with the equivalent of a single fund of funds that would require next to no action on your part, other than simply adding money.
When being dead is a good thing!
A lot of investors will be thinking what is the point of paying higher fees, when I can do it myself. At the end of the day, most investors returns are going to be the market average minus fees, so the cheaper the fees the better returns.
The only problem is that this relies on investors behaving in a sensible way and unfortunately most investors don’t. When Fidelity, one of the biggest investment companies in the world did a little investigation into which of their clients investments did the best they found something very interesting.
The best investors were either dead or inactive i.e. they’d forgotten they even had an account. It goes without saying that these guys didn’t mess around with their portfolios, rather, they just left them alone.
Psychology – ignoring the noise
However strong we think we are, it is too easy to get influenced by the world around us. In the bad times when the markets fall lots of investors sell all their shares when they are cheap and then buy them all back when they’ve become expensive.
Even in the good times there’s a constant stream of financial information advising us what to do based on recent past performance or some future event. “US stocks are over valued you better sell,” or “Brexit means UK stocks are cheap you better buy!”
Investors need to be really strong to ignore all this and that’s where Robo advisors or a single fund comes in. You don’t need to pay attention to the markets and get influenced by the financial media. You just set up a standing order and forget about it.
The bottom line
So what’s the optimum number of funds then? These days investors only really need a single fund. For the moment expats will probably have to settle for a Robo-Advisor to get the same results, though.
