How to Build a Balanced Mutual Fund Portfolio

Investing your money may seem a little daunting, and no wonder--hearing terms like ‘diversification,’ ‘asset allocation,’ ‘risk-tolerance’ and ‘volatility’ is kind of like being stuck in a horrible crossword puzzle you can’t escape. Fortunately, beyond the buzzwords, investing in low-risk stocks is a lot less complicated than it sounds. It’s mostly about creating a plan and sticking to it, not about following the NASDAQ day-to-day.

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Building a mutual fund portfolio is how we build that plan, a long-term financial goal where low-risk investments are all pooled together to create steady, incremental growth. This way you won’t have to worry--it’s just about adding to your fund over time and letting it sit. Active investment--buying and selling stocks on hunches, always looking out for the latest Apple--is kind of like going to the slot machines: there’s a chance you’ll win something, but the house usually wins. So instead of being the gambler, choose to be the house. That’s how you build your mutual fund portfolio, based on market conditions, not on a crazy chance.

First off you have to ask, what’s your age, and what’re your goals? "Let's start with the concept that when we're young, have few assets, are willing to take risks, and seek capital accumulation, we should emphasize common stocks," says Jack Bogle, founder of the Vanguard Group and inventor of the fist index fund. “But as we age, our assets grow, we gradually become more risk averse, and increasingly seek income, we should emphasize bonds."

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In other words, when you’re young and have little money, it doesn’t really make sense to invest in government bonds, which have low-interest rates and can’t be easily sold. But if you’re older and have a good amount of savings bonds make sense, since even incremental interest is enough to make you a living if you’ve accumulated enough. Portfolios are all about goals: Are you looking to make money in the short term and have little to lose, or are you building a college fund for your newborn baby? Whichever you choose will determine what kind of balance you want.

If you want an easy rule of thumb, just use age to determine priorities: 20 percent government bonds when you’re in your twenties, 80 percent when you’re in your eighties. Within that, pick a diverse selection of options. It all about risk tolerance.

"Risk tolerance is specific to each individual. Risk-averse investors may want to hold a combination of the model portfolio and cash, which will reduce overall risk," says Yale University’s chief financial officer David Swenson. "As wealth increases, tolerance for risk may increase. As investors grow older, tolerance for risk may decrease. Each individual needs to find a portfolio that matches their risk preferences."

Determining what you’re willing to lose is the chief thing that directs your investment strategy: If you’re uncomfortable losing 10 percent of your savings you’re probably low-risk, and if you’re unsatisfied with a 10 percent increase you’re probably high.

Another determining factor is this: How much do you want to worry? If you’re the kind of person who doesn’t want to think about this at all you might consider investing in index funds, portfolios of investments arranged by a financial institution (such as a bank) which comes with a fee. Index funds are either passively or actively managed--active managed index funds have a financial manager making decisions, while passive funds are determined by market rates. Actively managed funds come with a fee because you have to pay the person making the decision, and also come with the risk of human error. It all depends on your needs.

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Funds can come at fees as low as 0.01 percent--more than reasonable considering what you get in return. "Be disciplined and stick to your savings plan, and keep an eye on the total fees you pay for managing your portfolio," says Gretchen Tai, who runs a pension fund. Consistency, therefore, is most important.

If you need help finding the funds most appropriate to your needs, check out Morningstar, a website used by investors to determine which mutual funds to invest in. If you need more options, check out the top ten mutual fund screeners, a perfect way to survey your options without needing expert knowledge.

Investing, in the end, is more about patience than knowledge, and incremental earnings rather than sudden gains. When it comes to choosing your mutual portfolio, remember, the more the merrier, and definitely safer. Diversification, really, is the magic word.