Step 5: Build Your Own

IF TARGET-DATE INDEX funds are so great, why buy anything else with your long-term investment money? There are two reasons: By building your own portfolio of index funds, you could potentially lower investment costs, while also putting together an investment mix that’s less risky or has a higher expected return.

To that end, you might start with three core holdings: a total U.S. stock market index fund, a total U.S. bond market index fund and a total international stock index fund. Total international funds hold stocks from both developed foreign economies and emerging markets. Fidelity Investments and Vanguard Group offer all three funds as index mutual funds, while BlackRock’s iShares and Vanguard offer the three as exchange-traded funds (ETFs). For a list of some of the total market index funds available, click here.

Also consider two alternatives. First, you could combine a total U.S. bond market fund with either SPDR Portfolio MSCI Global Stock Market ETF or Vanguard Total World Stock Index Fund. These two funds track both U.S. and foreign stock markets. The Vanguard fund is available as a mutual fund and an ETF. The combination of a total bond market fund and a global stock index fund would leave you holding just two core funds, though perhaps with more in foreign stocks than you like.

Second, you might buy Charles Schwab’s total market funds, which have low expenses and no investment minimums. But because the Schwab International Index Fund owns only developed markets, you’d probably want to tack on a fourth fund—one that focuses on emerging markets.

These various total market funds are among the most competitive areas of the index-fund market, so you can now find funds with tiny annual expenses—lower even than those on target-date index funds.

On top of that, by building your own portfolio, you can purchase the precise mix of U.S. bonds, U.S. stocks and foreign shares that you desire. Your personal risk tolerance will drive how much of your long-term investment money ends up in bonds. Meanwhile, the split between U.S. and foreign stocks is a matter of considerable debate. Some experts advocate as little as 20% of a stock portfolio in foreign shares, while others go as high as 50%. Whatever mix you settle on, make a point of writing down what percentage of your portfolio is earmarked for each fund. During periods of market turmoil, that written record will remind you of the strategy you settled on in calmer times. It will also help when rebalancing—a topic discussed in step 9.

Do you consider yourself an investment junkie—and hence you’re willing to buy more than just total market funds? It’s time for steps 6, 7 and 8.

Next: Step 6: Fend Off Inflation

Previous: Step 4: Off the Shelf

Articles: Own It All and Almost Zero

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