User:BeBH65/Portfolio construction

 : Rather than trying to pick specific securities or sectors of the market (US stocks, international stocks, and US bonds) that in theory might outperform the overall market in the future, Bogleheads buy funds that are widely diversified, or even approximate the whole market. The best and lowest cost way to buy the whole stock market is with index funds (either through traditional mutual funds or exchange-traded funds (ETFs)). Bogleheads create a good plan, avoiding attempts to time the market, and then stick with it, "stay the course". This consistently produces good outcomes over the long term.

From Laura

After settling on your primary asset allocation you can turn to selecting funds that flesh out your desired asset allocation and placing them in the most tax efficient manner. If you do not have taxable accounts, then tax efficiency isn’t a huge concern but it is still a factor that should be considered. It is usually best to consider all of your investments together. If you are married you should usually blend accounts held by both spouses into one unified portfolio.

The best place to start building a portfolio is by making a list of all your current investment accounts and the investments in each account. Next, start with the account types that offer the most limited investment choices, which are usually 401k and 403b type plans. These plans normally offer limited fund choices, so starting here and building around the best fund choices is often the best idea. Look at all the funds available in your 401k and list the ones with the lowest expense ratio from each category (US equity, international equity, bonds, etc).

Finally, you must consider the tax consequences of investing, especially in taxable accounts. Generally, the most tax efficient way to use your different accounts is (our thanks to Taylor Larimore and David Grabiner for this list):

1. Invest as much as possible in your tax-deferred and tax-free accounts. 2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts. 3. Use only tax-efficient funds in taxable accounts. 4. If all else is equal, put funds with higher expected returns in tax-free (Roth) accounts in preference to tax-deferred (traditional 401(k), 403(b), traditional IRA) accounts.

Introduction
preprequisites :
 * ready to invest
 * risk assessment - AA

-- from Laura

After settling on your primary asset allocation you can turn to selecting funds that flesh out your desired asset allocation and placing them in the most tax efficient manner. If you do not have taxable accounts, then tax efficiency isn’t a huge concern but it is still a factor that should be considered. It is usually best to consider all of your investments together. If you are married you should usually blend accounts held by both spouses into one unified portfolio.

The best place to start building a portfolio is by making a list of all your current investment accounts and the investments in each account. Next, start with the account types that offer the most limited investment choices, which are usually 401k and 403b type plans. These plans normally offer limited fund choices, so starting here and building around the best fund choices is often the best idea. Look at all the funds available in your 401k and list the ones with the lowest expense ratio from each category (US equity, international equity, bonds, etc).

Finally, you must consider the tax consequences of investing, especially in taxable accounts. Generally, the most tax efficient way to use your different accounts is (our thanks to Taylor Larimore and David Grabiner for this list):

1. Invest as much as possible in your tax-deferred and tax-free accounts. 2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts. 3. Use only tax-efficient funds in taxable accounts. 4. If all else is equal, put funds with higher expected returns in tax-free (Roth) accounts in preference to tax-deferred (traditional 401(k), 403(b), traditional IRA) accounts.

Bogleheads® principles for portfolio construction
The BH investment principles include the following principles directly focused on portfolio construction

Diversify
xx comment on total market -- look in old version of approximating target date fund

xx copy portion of BH principles page + expand


 *  Watch the video

Rather than trying to pick the specific securities or sectors of the market (US stocks, international stocks, and US bonds) that will outperform in the future, Bogleheads buy funds that are widely diversified, or even approximate the whole market. This guarantees they will receive the average return of all investors. Being average sounds bad, but it is actually a great thing. That's because most investors perform worse than average after taking into account the high fees they can pay for actively managed funds. If there were no fees, then every year, half of all actively managed funds would outperform the index (because the index is the average). It might seem like an investor would just want to invest in those outperforming funds. But there is no persistence to the results. Funds that outperform one year tend to underperform in the next. And in the real world, investors pay high fees on managed funds. That means more than half of those actively managed funds usually underperform index funds over the long haul.

Use index funds when possible

 *  Watch the video

The best and lowest cost way to buy the whole stock market is with index funds (either through traditional mutual funds or ETFs). The first such retail fund was pioneered by Jack Bogle in 1976, and was called "Bogle's folly" by some members of the financial industry. Today, Vanguard Total Stock Market Fund is the largest mutual fund in the world, and is also one of the best values. Fund expenses weigh in at about one-tenth the industry average. By purchasing this single fund, an investor owns a piece of essentially every public company in the US. This diversification lowers risk, because the failure of any one company does not have a big effect. The investor is still exposed to the high volatility of the overall stock market, but in exchange the investor gets to participate in whatever returns the market is generous enough to give over time.

Bogleheads also like to use low cost index funds to hold international stocks, so they can take advantage of economic growth in other countries. Vanguard Total International Stock Market Fund is one such fund that owns a portion of most international public companies in both the developed and developing worlds. International equity may or may not provide higher growth than US equity over time, and it has historically been even more volatile than domestic stocks. The amount held varies, but is normally between 20 to 40% of the equity allocation.

Simplicity
xx copy portion of BH principles page + expand

Keep costs low
xx copy portion of BH principles page + expand It is critical to keep investing costs low. The following pages examine mutual fund costs:
 * Mutual funds and fees
 * Mutual funds: additional costs


 *  Watch the video



The difference between an expense ratio of 0.15% and 1.5% might not seem like much, but the effect of the compounding over an investing lifetime is enormous. After 30 years, a fund with a 1.5% expense ratio will provide an investor with several hundred thousand dollars less for retirement than a 0.15% index fund with the same growth. And remember that most managed funds actually underperform index funds. Costs matter, and investors need returns compounding for their own benefit, not the benefit of fund companies who skim unnecessary fees off the top. Figure 2. is an example showing that 1% of additional costs will reduce available retirement funds by 10 years.

Unfortunately, some 401(k) plans do not offer any index funds. In this unfortunate situation, Bogleheads generally look for the largest, most diversified funds with the lowest fees. These "closet index funds" tend to perform relatively like index funds (although with higher fees). If you need to find the "least-bad" funds available in your 401(k), start by looking for the funds with the lowest expense ratios.

Selecting the good fund from a plan
In constructing a portfolio one often does not have a full freedom in selecting the funds. Often a plan (like 401(k)) or account (like IRA) has a limited choice of funds.

Scan your fund listings and look for the index funds with low expense ratios. In most cases, the lowest-expense funds will be index funds. If not good funds are available then you will need to approximate them as explained in the sections below.

Selecting a suitable US stock fund
Find the lowest fee fund. In most cases, this fund will be an S&P 500 index fund. Note that the actual name of the fund might not actually be S&P 500 Index Fund. It might be called 500 Index, Equity Index, Large Cap Index or some other name. You may need to read your plan information carefully determine the fund’s composition.

Your plan might also have a Total US Stock Index fund. If the expense ratio is not much higher than the S&P 500 Index fund in your plan (if any), then so much the better—-it's generally easier to work with a Total US Stock Market index fund when creating a portfolio. If you don't have a Total US Stock Market Index Fund, but you have a 500-index fund an extended market index fund, then you can pair these two funds as described below.

Selecting a suitable International stock fund
Look for a fund with a name like International Index, Total International Index, International Equity, MSCI All-World ex US, or other fund names that suggest a total market international fund. Generally, if there is an index fund, it will be the least expensive international fund in the plan. You may need to study your funds carefully to find the right fund.

Selecting a suitable Domestic bond fund
Look for a bond fund with "index" or "total" in its name. You will likely need to study your funds more closely to see if there is an index fund in your plan. Look for a fund that tracks the Barclays Capital US Aggregate Bond Index, which is the same index the Vanguard Total Bond Market Index Fund (VBMFX)tracks.

Asset allocation portfolios
xx focus more on funds than on asset-classes

Strategic asset allocation strategies range from simple to complex. Lazy portfolios are designed to perform well in most market conditions. Most contain a small number of low-cost funds that are easy to rebalance. They are "lazy" in that the investor can maintain the same asset allocation for an extended period of time, suitable for most pre-retirement investors.


 * John Bogle is a proponent of simple asset allocation portfolios. He frequently advises that most investors should allocate investment portfolios using two asset class index funds: a U.S. total market stock index fund, and a U.S. total bond market index fund.


 * A widely held portfolio among Bogleheads® Forum members is the three fund portfolio allocating investments among a U.S. Total market stock market portfolio; a Total International stock market portfolio, and a U.S Total bond market portfolio.  This portfolio is frequently expanded to include a fourth asset class, U.S. inflation-indexed bonds.


 * Some strategic asset allocation funds add additional asset classes or sub-asset classes to the asset mix. For equity investments these additions can include value stock funds, real estate funds (U.S. and international), gold, and commodity futures funds. Fixed income additions to the asset class palette include U.S high yield bond funds, international developed market bond funds, and emerging market bond funds. In addition, depending on an investor's risk tolerance preferences or tax situation, bond market allocations can be restricted to U.S treasury bonds or investment grade municipal bonds.

Tools and calculator
Investors should look at all of their accounts as a unified portfolio to construct a portfolio that is low cost, well diversified, and tax efficient. You can use various utilities to design and manage portfolios. Most tools cannot automatically compose your ideal portfolio, but you can use the tools to enter two or three models that you composed, and then you can compare and contrast the results, looking in particular at the blended expense ratios and the totals of each asset class. Alternatively using a spreadsheet to maintain a portfolio can be another way of easing the burden.

Morningstar X-Ray
A tool for breaking down a portfolio into asset allocations and style box box views. See the main article for additional information.

Vanguard Portfolio Watch
A tool in the Vanguard website for Vanguard clients that breaks down portfolio into asset classes; see main article for more information and caveats/limitations of the tool.

Spreadsheet

 * Using a spreadsheet to maintain a portfolio
 * Asset Allocation Spreadsheet - a Google spreadsheet created by Hoppy08520, with a link to documentation, that can help setup a multi-account portfolio.

More example Portfolios
xx focus more on funds than on asset-classes

Bogleheads advocate investments in well-diversified, low-cost index funds. The following articles provide examples of simple broadly diversified investment portfolios.
 * Target date retirement funds - all-in-one funds that adjust the asset allocation over time, aimed for investors who want simplicity of managing their investments.
 * Three-fund portfolio - often recommended by Bogleheads attracted by "the majesty of simplicity" (John Bogle's phrase), and for those who want finer control and better tax-efficiency than they would get in a target date fund.
 * Four-fund portfolio - Vanguard recommends a four-fund portfolio for global diversification by adding international bonds
 * Lazy portfolios - lists more examples of portfolios designed to perform well in most market conditions. These contain a small number of low-cost funds that are easy to rebalance. They are "lazy" in that the investor can maintain the same asset allocation for an extended period of time without needing adjustments and are suitable for most pre-retirement investors.

Funds that implement target asset allocations
An asset-allocation fund or a balanced fund is a mutual fund that holds multiple asset classes in a single portfolio. Typically these funds hold a stock component; a bond component, and in some instances, a cash component. Many balanced funds maintain a fixed asset allocation; some pursue a variable allocation policy, changing asset weightings according to market conditions. Target date funds are balanced funds that gradually change asset class weightings in harmony with an investor's supposed changing need for a lower risk profile over time. .

These funds attempt to provide investors with portfolio structures that address an investor's age, risk appetite and investment objectives with an appropriate apportionment of asset classes. However, critics of this approach point out that arriving at a standardized solution for allocating portfolio assets is problematic because individual investors require individual solutions.

Choices for equity
xx focus more on funds than on asset-classes

For equity allocation a US investor needs to choose the split between domestic (=US) and international (=ex-US) stocks. At the same time the investor needs to decide whether to follow the full market or to select a portion (large-cap, mid-cap or small-cap); or to tilt in style (value, blend or growth); or to allocate among sectors or favor REITS.

Choices for bonds
xx focus more on funds than on asset-classes

Bogleheads like to own bond funds instead of individual bonds for convenience and diversification. Using individual corporate or municipal bonds require a very large holding in order to achieve the broad diversification and increased safety of a bond fund. The high number of different bonds in bond funds let you ignore the risk of any one bond defaulting. Interest rate risk can be managed if you select funds with short and intermediate-term duration, while default risk can be managed by selecting funds with high credit ratings. The central idea here is that your bond holdings are for safety, to reduce violent up and down swings in overall portfolio value. Bogleheads tend to take risks on the equity side, not the bond side.

Bogleheads typically divide bond allocations between just two categories: nominal bonds such as the Vanguard Total Bond Market Fund, and U.S. Treasury Inflation Protected Securities (TIPS) such as the Vanguard Inflation Protected Securities Fund. The use of a TIPS fund provides additional diversification as well as inflation protection.

I-Bonds are also an attractive alternative to TIPS. They are sold directly to investors by the U.S. Treasury; can be bought using your IRS tax refund; don't need to be held in a tax-protected account; and accrue interest tax-deferred for up to 30 years. There are annual limits on how much you can buy in I-bonds.

Approximation of desired funds

 * Approximating Vanguard target date funds - explain +links
 * approximate total stock market - explain +links
 * approximate total international - explain +links
 * approximating 3 or 4 fund portfolios - To approximate a 3 or 4 fund portfolio the same procedure can be followed as explained to approximate a Vanguard target date fund

Tax Considerations
Consideration should be given to tax efficiency; which is an approach to minimize the effects of taxes on your portfolio. Tax efficiency should be considered after you select your asset allocation.

Maintain your portfolio
Once you have your portfolio, it's important to rebalance when your funds deviate (more than 5%-10%) from your asset-allocation plan. This is accomplished by transferring from over-allocated asset classes to under-allocated asset classes. Target date retirement funds automatically rebalance for you.