Portfolio Management

For the many investors who only own mutual funds, working directly with fund companies may be sufficient to meet their needs. But for those who want to invest in individual securities, in addition to or exclusive of mutual funds, brokers can provide access and other conveniences. You can buy stocks and bonds as well as mutual funds from many different fund companies through a broker-and keep all your investments in one brokerage account. However, you must carefully consider the costs involved in using a broker and choose one that best serves your investor profile.

When constructing your portfolio, you should properly allocate your funds among the various asset classes. Diversification is the best way to minimize risk and maximize returns. Changes in the market and in your time horizon will necessitate changes in your portfolio. It is important to regularly consider rebalancing your assets in order to stay on track toward your goals.

How do I choose a broker?

When looking for a broker, figure out the total cost of doing business with each broker. That number will depend on what kind of investor you are.

First, how much do you want to invest? The more you put into a brokerage account, the less you will pay in fees. Next, ask yourself how much you plan to trade. Commissions and account fees are also determined by trading frequency. Finally, how much service do you want from your broker? If you need little advice, you can save money by going with a discount broker. If you need a great deal of guidance, a full-service broker will cost more.

What do I do if I have a problem with my broker?

The first thing you should do is talk to the broker. If the broker does not address your concerns, you should write to the compliance or legal department of the brokerage firm. If the firm does not respond to your satisfaction, you can complain to the National Association of Securities Dealers.

While the NASD may investigate and bring an enforcement action against a firm for misconduct, it may not necessarily result in any money being returned to you. Many brokerage account agreements contain an arbitration clause, so most investors have to go through the broker's arbitration process if they want to try and recover lost funds. The NASD handles about 90 percent of securities arbitrations in the U.S.

How do I decide which asset classes to invest in?

Trying to time the market is risky business. No one is ever really sure when different segments of the market will rise or fall. Diversifying a portfolio among many different asset classes and sticking to a disciplined investment strategy is a safer way to invest for the long term. Proper asset allocation minimizes risks and volatility.

Before deciding which types of securities to buy and in which proportions, you should determine your financial goals, risk tolerance and time horizon, along with liquidity needs and tax status.

Different asset classes react differently to market conditions and serve different roles in a portfolio. For example, while stocks are more volatile than bonds, stocks tend to deliver higher returns over the long term. Bonds, on the other hand, generate predictable income, but they are subject to interest-rate and credit risk that stocks are not.

Therefore, you need to balance asset classes in your portfolio in ways that reflect your investment profile. For example, a younger investor has a long time horizon until retirement and can afford to invest more aggressively, so he or she might allocate 60 percent of his or her portfolio to stocks and 40 percent to bonds. An older investor who needs a regular income stream in retirement may shift his or her portfolio to a more conservative 40/60 stocks to bonds mix. Investors who need immediate liquidity may want to keep a portion in cash.

Then you want to diversify within asset classes to include many different types of securities. For example, you may want to balance growth stocks with value stocks, large-cap stocks with small-cap stocks and domestic stocks with foreign stocks. On the bond side, you may want to include both conservative Treasuries and aggressive junk bonds in your portfolio, along with both long- and short-term debt securities.

Your asset allocation model can also help you maintain a disciplined investment strategy, so you are not tempted to chase asset classes with temporarily hot returns and dump others that are bottoming out and about to rebound.

When should I rebalance my portfolio?

When certain segments of the market outperform, that portion of your portfolio may grow in value so that it exceeds your original allocation. For example, if you allocated 60 percent of your portfolio to stocks and the stock market takes off, that allocation may come to represent 70 percent of your portfolio. At that time, you may wish to rebalance back to your original allocation by selling some stock and buying more bonds. You should also rebalance when your personal situation changes-such as your time horizon shortening and your risk tolerance declining.

It is best to think of your allocation percentages in terms of ranges, because rebalancing can be costly-you will have to pay for both the transactions and the taxes incurred.

What is "dollar-cost averaging"?

It is common sense that you should always buy low and sell high with your investments. The problem is, you never know when an investment is topping or bottoming out. Instead of trying to time the market, use a strategy called dollar-cost averaging.

If you buy a fixed dollar amount of an investment on a regular schedule-such as $100 worth of shares of your mutual fund every month-you will end up buying more when the price is low and less when the price is high. The cost of the investment will often be less if you dollar-cost average than if you pay a one-time lump sum.

Dollar-cost averaging also forces you to remain disciplined about saving and investing, even when the market is down and you might be tempted not to buy falling shares. Most investors dollar-cost average through their employer-sponsored retirement program by contributing a set amount every pay period and through automatic monthly contributions to college savings and retirement plans.