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8 Steps to Creating a Diversified Asset Classes Investment Portfolio

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

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

In Part 1: “How to Build an Investment Asset Management Strategy”  you learned the best, research-supported, investing method and why to invest with index funds. Today you will learn the steps to take to create a diversified asset classes portfolio.

Future investment articles continue with the how of implementing asset classes investing with index funds. 

The great part about structuring a diversified index fund DIY portfoio is that once it’s complete, it requires minimal attention. Annual rebalancing and updating prices, dividends and capital gains and you’re done managing your investments. 

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.

8 Steps to Creating a Diversified Asset Classes Portfolio

How to create a DIY diversified asset classes index fund portfolio

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 best to contribute the maximum amount allowable by law. In 2018, you are allowed to contribute $18,500 to your 401(k), 403(b and 457 plans. You can contribute up to $5,500 to an IRA or Roth IRA. If you’re over 55 you’re allowed to contribute $6,500.  If you can’t swing that much, make sure to contribute at least enough to get a full employer match.

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 Schwab office, you can open the account in person.

Also, consider investing in a taxable brokerage account, for additional wealth-building. 

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 or follow the online instructions, to learn how to transfer funds from your bank account into the brokerage account.

This is the most important step to securing your financial future.

Next, figure out how you’ll handle it when your investment values drop.

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. Check out the “Sleep at Night Guide to Risk” to estimate your risk tolerance level. 

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.

Remember that even by investing in just three index funds, you’ll have exposure to thousands of stocks and bonds. 

Step 5: With your risk tolerance in mind, figure out what percent of your total investment funds to allocate to stock and bond investments.

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.

Low Risk Tolerance-Conservative Investor

40% Stock Funds – 60% Bond Funds

You are either a senior citizen or uncomfortable with the ups and downs in your financial portfolio.

Your portfolio will have more fixed assets (cash and bonds) and less stock investments than the more aggressive portfolios.

30% U.S. short-term bonds
30% TIPS fund
40% All world stock

Moderate Risk Tolerance Investor

65% Stock Funds – 30% Bond Funds – 5% Real Estate

You can tolerate some volatility, but are in 50’s and 60’s and don’t want too high a percent of risky assets. 

30% Short term bond fund
40% Total U.S. stock market
25% All world (ex-US) stock
5% REIT

Hi Risk Tolerance Aggressive Investor

70% Stock Funds – 20% Bond Funds – 10% Real Estate

You understand that in the long term stocks outperformed all other asset classes. You are confident that in the long term even the largest portfolio declines will be offset by increases in value, due to growing global companies.

Your portfolio will have more stock investments and fewer fixed investments.

30% Short term bond fund
45% Total U.S. stock market
25% All world (ex-US) stock
10% REIT

Step 6: Pick the funds to go into your portfolio

Choose the low fee index funds from the available selection from your workplace retirement account. For a Roth IRA or taxable brokerage account, choose low fee index funds from the available selection. It doesn’t really matter if you choose Vanguard, Schwab, Fidelity or iShares index funds. 

Step 7: Set up the automatic transfer into your selected funds.

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. Go into the online investment portal and choose the percentages you want directed towards the specific funds. Or, if you prefer some human guidance, call and speak with a representative at the brokerage firm. 

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

Finally, don’t look at your statements. I repeat, don’t look at your statements every day or week. The fund values go 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.

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.

For free investment management and rebalancing for your DIY portfolio, check out M1 Finance.

Updated; December 29, 2017

    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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