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3 Ways to Set Your Portfolio Up for Success

Consolidating your investments can make them easier to track and manage. (Getty Images)

Managing an investment portfolio doesn’t have to be difficult. A few simple strategies are enough to get you started building wealth for your future livelihood. If you can get these three things right, you are probably setting yourself up for success.

1. Keep it simple. The financial universe has gotten extremely complicated. Stocks, bonds, options, annuities, mutual funds and exchange-traded funds are just a few of the dizzying array of financial products and vehicles you may come across. While all likely have some merit in various scenarios, you need to make sure your portfolio matches your needs. A very easy rule of thumb is to never invest in something you do not understand. As we learned through the great recession, complex financial products or structures don’t always make things better for the economy or our financial system, and the same is true for your portfolio.

[Read: How Your 401(k) Balance Stacks Up.]

One great way to keep things simple is by being organized. Most people don’t need 15 different accounts across a variety of different institutions. Far too often individuals and families have a patchwork quilt of accounts that were opened prior to marriage, in a previous marriage, from a previous employer or by parents or grandparents. If you don’t have a solid grasp of where your assets are and what they are invested in, you can’t easily ensure that they are all working together toward your ultimate goals. Consider consolidating your accounts whenever it makes sense to simplify your financial life.

2. Keep an eye on taxes and fees. The challenging truth about investing is that no one knows if the market will go up or down tomorrow. In the short-term, the direction of the market is something that is out of your control. Considering that, it’s a good idea to spend your time focusing on the areas of your portfolio that you can control.

Taxes. While the evasion of taxes is an illegal practice, the avoidance of taxes is highly encouraged and often incentivized. Just like you focus on the asset allocation and diversification of your portfolio, you should also pay attention to the asset location (which accounts hold various types of investments). Holdings that generate ordinary income, such as bonds, should likely be held in a tax-deferred traditional 401(k) or IRA. Investments that create qualified dividends or generate capital gains might serve you better when housed in a taxable account because of the favorable tax treatment. High growth assets should likely be held in a Roth IRA to maximize the tax-free growth potential.

[Read: How to Avoid 401(k) Fees and Penalties.]

Fees. Fees come in a variety of shapes and sizes, but, just like taxes, you get to control, to an extent, what you pay. Make sure you understand the different types of fees in your portfolio:

  • Transaction fees. These are the fees assessed for buying and selling certain types of holdings. Transaction fees can add up with excessive trading, but there are a number of mutual funds and ETFs that trade for free on various platforms. If you are paying transaction fees, make sure the holding justifies the additional cost and the fees charged are in-line with competitors.
  • Commissions. A number of financial products will pay commissions to the advisor who sold them on the front-end, back-end or on a regular basis. Consider using no-load products, and, if your advisor or institution doesn’t offer no-load options, ask them why not.
  • Internal expenses. Pooled investments like mutual funds or ETFs charge an internal expense for the fund company maintaining the investment. Index funds should have very low internal expenses (some as low as 0.05 percent). whereas active funds may have expense ratios greater than 1.5 percent. If the funds in your portfolio fall on the higher end of the spectrum, make sure you understand why the higher cost is justified and verify there are not lower-cost alternatives available.

3. Know yourself. One of the most damaging forces that can derail your investment portfolio is your own behavior. In order to protect yourself, make sure you understand the following:

Risk tolerance. This is how much volatility you can experience before pulling your hair out. Your risk capacity is how much mathematical volatility your portfolio can handle before compromising your long-term probability of success. These two do not always align, but they should both always be considered in portfolio construction.

You are not Warren Buffett. Unless you can dedicate the time and attention required, focused portfolios can be dangerous for the average investor. Diversification is what will help keep your money safe.

Don’t be afraid to ask for help. Many people can self-manage their financial situation, but there are three times when it may make sense to seek professional guidance:

  • You have a lot of wealth to manage. The gravity of your financial decisions could become greater than you feel comfortable managing alone. A 10 percent loss on $1,000 is a bad day. A 10 percent decline on $1 million could change your retirement.
  • Your tax situation is complicated. Your situation may become more complicated as you take on various types of investments. Maybe your tax return has grown from two pages to a short novella or you now have access to employer incentives, own a small business or have various real estate holdings. Any of these more complex scenarios might warrant the services of someone who is well-versed and experienced in those areas.
  • Life gets busy. With the balancing of work, family, community involvement and social activities, it is easy for your finances to take a back seat. Whether you like it or not, one day someone else will need to steer the ship, so you want to make sure your spouse or heir receives the necessary information before that shift takes place.

[See: 10 Ways to Make Your 401(k) Balance Grow Faster.]

Financial independence is the culmination of taking small steps that eventually lead to life changing opportunities. The power of these three concepts can be a starting point to build wealth for the future. Building up investments that work for you will propel you to a financially successful retirement.

Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, “The Money-Guy Show”.

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