To find the right fund or strategy for a portfolio, advisors typically back into their investment selection. Dan Kern, chief investment officer at TFC Financial Management, for example, starts with asset allocation, which he believes is the most important investment decision. Asset allocation — your exact mix of investment categories such as stocks and bonds — is largely responsible for a portfolio’s performance.
Only after you’ve settled on an asset allocation and know the type of investment style you are looking to fill can you home in on the right actively managed strategies. For example, if you conclude that you need some small cap growth exposure, then you can spend time evaluating just those types of funds instead of the entire universe.
Many investors make the mistake of being “collectors of funds,” Kern said. They become enamored with several individual mutual or exchange-traded funds without considering how they all work together. They may not realize that those funds may have significant overlap and do little for actual portfolio diversification.
“I remember back in 2000 when I had clients tell me, ‘I’m diversified; I have half a dozen funds,’ but they were all tech funds or funds holdings big tech positions,” Kern recalled. When the dot-com bubble burst, those portfolios took a big hit, because their holdings weren’t balanced out by less volatile fare.