8 Steps to Creating a Diversified Asset Classes Portfolio

By in Advanced Investing, Asset Allocation, Automatic Saving, Bond, Investing, Mutual Funds, Stocks, Video | 8 comments

Part 2: What are the Steps to Creating a Diversified Asset Classes Portfolio?

In Part 1: “What is the Best Investing Method”  you learned the best investing method and why to invest with index funds in a diversified asset classes portfolio in line with your risk tolerance. Today you will learn the steps to take to create a diversified asset classes portfolio.

Future articles continue with the how of implementing this research tested diversified asset classes portfolio.

You’ll benefit from my decades of successful investing experience by using this proven and successful step by step approach. The only thing I get out of this is the satisfaction of knowing that you are learning smart money strategies.

The great part about structuring this type of investment portfolio is that once it is complete, it requires minimal attention. That means, you can feel confident that your investment portfolio is in place. You will be confident that part of today’s income is regularly going to fund tomorrow’s expenses.

Taking control of your investing today eliminates financial worries tomorrow.

Asset Allocation with Diversified Asset Classes

Investing is for Long Term Goals

Invest today to have money for your future wants and needs.

Investing is only for long term goals. If you need money in five years or less, then place those funds in a short term certificate of deposit, Government I bond, or money market mutual fund. Investing offers the opportunity for higher returns, but along with those higher returns, comes more volatility. You don’t want the money you need for a home down payment in three years to drop in value in year two.

Steps to Creating a Diversified Asset Classes Portfolio

Here’s the overview. In future articles you’ll learn exactly how to implement each step.

Step 1: Where do I place my long term investable funds?

Now that you’ve heard the warning, only invest with long term funds, let’s talk about where to put your investment funds.

If your workplace offers a workplace retirement fund such as a Roth IRA, 401(K), or 403(B) where you contribute part of your pre tax salary, then that is where to open your investment account. It’s preferable to contribute the maximum amount allowable by law as shown in the chart below. If you can’t swing that much, make sure to contribute at least enough to get a full employer match.

2013 retirement plan contribution limits

2013 Retirement Plan Contribution Limits

The human resources office will tell you how to open the account and start directing your money to the appropriate mutual fund. In the upcoming articles you’ll learn which mutual funds to choose and in which percentages.

If your workplace doesn’t offer a retirement plan, open a Roth IRA on your own. I recommend going to a discount broker such as Charles Schwab, Fidelity, or Vanguard. If you want to start investing with a small amount, Charles Schwab has a $1,000 investment minimum for most accounts (the minimum opening balance is waived with automatic deposits). All accounts can be opened online, or if you live in an area with a bricks and mortar discount broker, you can open the account in person.

Step 2: Start regularly transferring money from your paycheck into your investment account.

Now that you opened the account, it’s time to fund it. Simply set up an automatic transfer from your paycheck, or bank account into the investment account.

If you’re transferring to a workplace retirement account, the human resources department will assist with the process.

Talk with a representative at the discount brokerage firm to figure out how to transfer funds from your bank account into the brokerage account.

This may be the most important step. Once you commit to transferring money into your investment account every pay period, you’ve made the decision to build wealth and secure your financial future.

Up until now, we’ve talked about how to get the funds from your bank account or paycheck into the investment account. In a future article, choose which mutual funds to invest in and in what percentages.

Step 3: Determine your risk tolerance or how much volatility you can stand.

If you are risk tolerant and/or in your 20’s or 30’s you can take a bit more risk because you have more time to make up any investment losses. Those nearing retirement or wary of even a small loss want to be a bit more conservative, with a larger amount in bond and cash assets and a smaller percentage in stocks.

Your risk tolerance drives your asset classes allocation decision. In Part 3: What is risk tolerance and how to figure out my own asset allocation you’ll get the tools to determine your own risk tolerance. 

Step 4: Choose the number of asset classes in which to invest. Decide how simple or complex you want your portfolio to be.

There’s no right answer here. If you are a “no muss no fuss” type of person and want to keep things simple, you can achieve a diversified portfolio with as few as two or three mutual funds. If you want a more targeted asset classes diversification, choose a few additional funds.

Step 5: With your risk tolerance in mind, figure out the percent allocated to each asset class.

This step integrates your comfort level with risk and number of preferred asset classes. A slightly aggressive investor desiring a simple asset classes portfolio might choose a portfolio with 33 percent in a diversified bond fund, 33 percent in a diversified international stock fund, and 34 percent in  a U.S. stock market index fund.

ASSET ALLOCATION-BEST INVESTMENTS

3 Asset Classes Diversified Portfolio

You’ll get several templates to help decide how to structure your own portfolio, based upon your personal risk tolerance and desired simplicity or complexity.

Step 6: Select one index mutual fund for each asset class. Choose from available funds in your investment account.

This step narrows down the field of available mutual funds to those that are included in your investment brokerage or workplace retirement account. You’ll learn how to choose the correct funds for your particular asset classes allocation.

Step 7: Inform the investment company into which mutual funds and in what percentages you want your contributions to go.

Now that you’ve determined your asset allocation and specific funds in which to invest, all that’s left is informing the investment company of your preferences. Continuing with the prior example, once you decide upon 33 percent in a diversified bond fund, 33 percent in a diversified international stock fund, and 34 percent in a U.S. stock market index fund inform the investment company .

Step 8: Once per year, rebalance your assets and revert to your original asset classes allocation.

Finally, don’t look at your statements. The portfolio value goes up and down, and there’s no benefit to worrying about short term performance for long term funds. Every year, rebalance your investment portfolio so that it returns to your predetermined asset allocation. This will force you to buy low and sell high.

Coming next in Part 3: Diversification Strategy: How to Figure Out My Risk Tolerance

Subscribe via email and don’t miss another article in the series:

Part 1: What is the best investing method?
Part 2; 8 Steps to Creating a Diversified Asset Classes Portfolio (today)
Part 3: Diversification Strategy: How to Figure Out My Risk Tolerance
Part 4: What are index funds and asset classes investing?
Part 5: How to buy low and sell high using a diversified index fund asset classes portfolio

Caveat; These articles are for information purposes only and not a recommendation to buy or sell any particular financial assets.

What are your asset class preferences? In what mutual funds do you invest?

    8 Comments

  1. We are about 60 stocks 30 bonds 10 cash with a mix of individual stocks, bonds and mutual funds with our investible assets. We also have some real estate and alternative investments.

    Some folks rebalance more often than once a year. It can be incredibly hard to talk yourself into selling a stock when the price is high, asset allocating helps.

  2. Nice tips. I’ve been advising my fiancée to invest in a more diversified portfolio and its great to direct her straight to another PF site explaining these ideas.

    Thanks Barb! Looking forward to the remainder of the series.

    moneystepper

    October 8, 2013

  3. An asset allocation can be as complicated or as simple as you want. I could have a pretty good asset allocation with about 4-5 index mutual funds. Over time, I made mine a little more complicated or more of a hedge against volatility.

    krantcents

    October 8, 2013

  4. @Marie-Thanks for sharing your portfolio. Looks like you are well diversified. I agree that rebalancing takes the guesswork out of what and when to sell/buy.
    @Krantc-Actually, as you stated, one’s returns can be quite good with just a few diversified index mutual funds. This is one of my favorite portfolios: http://www.marketwatch.com/lazyportfolio/portfolio/second-grader-starter. Only 3 funds and it beat the S & P 500 over the last 10 years.

    Barbara Friedberg

    October 9, 2013

  5. Newb question! If you open your own Roth IRA, is there any way to set it uo to come directly out of your paycheck so that the funds are not initially taxed allowing you to take home a higher percentage of your paycheck than of you contributed with only your net pay?

    femmefrugality

    October 10, 2013

  6. Hi Femme,

    A Roth IRA is contributed with “after tax” dollars. But.. the beauty is that the money grows tax deferred and when you take the money out in the future it is tax free.

    You may check with your hr to ask if they can transfer the money to your Roth IRA account.

    Keep the questions coming, they will help others.

    Barbara Friedberg

    October 10, 2013

  7. Hi Barbara,
    A mistake people often make is that they think by buying numerous funds and asset classes that they are diversified. It actually adds risk to their portfolio. Great explanations above.

    Charles@gettingarichlife

    October 12, 2013

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