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5 Go-To Investments for Your Portfolio Makeover

Sat, 7 Jun 2014

Investors looking to upgrade, diversify, and simplify their portfolios can start here, says Morningstar's Christine Benz.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five.

Sitting in for Jeremy Glaser this week is Christine Benz, our director of personal finance. She just finished five makeovers for Morningstar.com's Portfolio Makeover Week, and she has brought five go-to investments if you're doing your own makeover.

Christine, thanks for joining me.

Christine Benz: Great to be here, Jason.

Stipp: Congratulations on finishing those five makeovers. I know they're a lot of work.

Benz: Thank you.

Stipp: You brought some investment ideas that came up in your makeover portfolios as good go-to investments that a lot of different investors may incorporate depending on their situation.

We're going to start with the least risky and move up the scale. The least risky is more of a classification of investments: stable value. Why might these be go-to investments for folks?

Benz: Stable value funds are only found inside of 401(k) plans. One reason I like them and oftentimes keep them when they show up in a "before portfolio" is that they do offer higher yields than you will earn on true cash instruments. They're not true cash instruments. There is perhaps a little bit of risk here, but these funds buy insurance contracts to help keep their net asset value stable. Historically, there have only been a few instances of stable value funds having any fluctuation in investors' principal value.

So you're able to earn a slightly higher yield than you can on true cash instruments, but you're virtually guaranteed that stability of principal. So this is a go-to investment for people who have cash in their portfolios and potentially want to be able to pick up a little bit of extra yield.

Stipp: Could it be a reason to not roll over some of your money out of a 401(k) if you want that exposure, given that they're only available on those vehicles?

Benz: That's definitely something to wrestle with and to think about. In one of the makeovers we did this past week, for example, the person who had the 401(k) fund wanted to hang on to it in part because she liked the stable value option. You'll want to think about how much of your portfolio you want to have in cash before you make a decision like that.

Some companies allow people to do partial rollovers. So you can keep enough in the stable value fund to keep that 401(k) plan open, but you can roll over the rest of your assets into long-term securities. That's a good compromise if that's available within your plan.

Stipp: Your next go-to investment, a pretty safe one on a number of fronts, is Vanguard Short-Term Inflation-Protected Securities. This is not your typical TIPS fund. Why is that?

Benz: Because it does focus on short-duration inflation-protected securities. The typical TIPS fund does have some interest rate sensitivity, and that tends to mean that there is volatility when interest rates are going up or down. When they're going down, that's good for you; when they're going up, that will depress the bonds' values.

This fund is more or less a pure inflation play without all of that interest rate-related noise. I see it as one of the least-risky investment options out there. It has very little interest rate sensitivity. Its duration is about 2.5 years. It has little to no credit risk. It invests almost exclusively in U.S. Treasury Inflation-Protected Securities. And then it does also have that layer of inflation protection. When the CPI is moving up, you get a little bit of a nudge up in the principal value of the bonds in the portfolio.

To me it looks like one of the least-risky investment options if you are wanting to step out a little bit on the risk spectrum beyond cash, and earn perhaps a slightly higher yield and a measure of inflation protection.

Stipp: It's not exactly a cash substitute, but it's pretty close with just a little bit more risk.

Benz: Yes.

Stipp: The third one is a balanced fund, also in the Vanguard family--Vanguard Wellington. This fund has come up in a lot of portfolios. Why do people like this fund so much, and why would you recommend it?

Benz: It does show up in a lot of investors' portfolios. It's the oldest balanced fund out there. It is fairly plain-vanilla in terms of its composition. It's usually roughly 65% equity, 30%-35% bonds. It is actively managed by teams from Wellington Management.

One of the most amazing things about this fund, in addition to its remarkably consistent performance, is just how cheap it is. I think of Vanguard Balanced Index as being a terrific core investment option. It charges about 24 basis points annually. This fund charges roughly 25-26 basis points, and you get all that great active management. Granted it's a large fund at this point, so arguably it's pretty wedded to large-cap stocks and doesn't have a lot of room to maneuver necessarily into mid-caps or even smaller large-caps. But I still think of it as a remarkably stable fund.

It's a really nice option for people who have maybe just one small account, say a rollover IRA that they don't think is going to get any bigger. Using investment vehicles like this one can be a great way to simplify. Dodge & Cox Balanced is another one I might point to in this vein.

Stipp: Your fourth go-to investment is a suite of investments--index funds. You've been able to use index funds in a lot in portfolio makeovers. Why is this a kind of investment that you find so handy in simplifying and streamlining?

Benz: Well for one thing you get a lot of diversification in a single shot. You also get a lot of diversification with a very low price tag. Oftentimes people may want to hang on to actively managed funds, but putting some index funds in there is a way to bring the overall costs down in the portfolio.

The other big reason, and one reason I use them a lot in the makeovers, is ease of use. So if you find that someone is dramatically underweight equity or heavy on equity, you can really move the needle very quickly using index products. You can get your asset allocation in line with where you want it to be, and I think investors managing their own portfolios might like that ease of use, too, as they do rebalancing or as they gradually get more conservative as they get closer to retirement.

Stipp: And for monitoring if you have an active manager that might be swinging around, it's a lot easier to know that you have a pure-play by using an index fund.

Benz: Exactly.

Stipp: Your last go-to investment is an international fund, Dodge & Cox International Stock. Why do you like this one and the exposures that it gives you?

Benz: First of all, I like Dodge & Cox in general. I have a lot of comfort recommending any of their funds--their pure equity, fixed-income, or balanced funds.

This fund I see as one of the best open actively managed foreign stock funds. It does have a value tilt, just as all of Dodge & Cox's other funds do. It is opportunistic, and one reason I like it is that I tend to recommend foreign stock funds that delve into emerging markets. I don't want to monkey around with separate emerging-markets holdings, and I'm not sure that most investors do, either.

So I often recommend this fund because it is a way to know that you are obtaining a fund where at least the managers are looking at emerging markets. Its costs are also really nice and low. Given the quality of this management team, given their very long tenures, 64-65 basis points currently, I think it's real bargain.

Stipp: Christine, I love your portfolio makeovers because you get great portfolio strategies and great investments like these all-in-one. Thanks so much for doing those and for joining me today.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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