Getting Better Returns from Your 401K and Mutual Fund Portfolio


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In Mutual Fund Investing Isn’t That Hard – Get Over It I discussed the big mistakes that investors make when handling a mutual fund portfolio or a 401K.  Most of these were things like not contributing enough, withdrawing your seed capital, or keeping too much in cash.  They really didn’t have much to do with the funds selected.  This is because most funds buy about the same stocks, so your results won’t be all that different if you do a good job of selecting funds or not.  It is really a matter of whether you’ll have $10M at retirement or have to get by with $8M.  The most important thing is to save and invest regularly and not use your 401K as a piggy bank to go on a trip or do a home kitchen upgrade.

There are ways, however, where you can improve your returns by a few percent, which will mean you’ll have a few million dollars more at retirement.  Doing these things really doesn’t take a lot more time, so if you are willing to learn and practice them, it is worth the effort.  So bookmark this post, send it to your friends, and refer to it often.  Here are the ways to get that few extra percent out of your mutual funds, which adds up to a lot of money over many years:

1) Buy the funds with the lowest fees.  If you have two different stock fund that have several billion dollars under management, they will hold basically the same stocks.  This is because they have so much money to invest that they need to buy many different stocks.  The managers buy their top pick, their next top pick, and probably their third and fourth pick in a sector.  So paying extra for a manager will probably not get you any higher return over long periods of time.  Their higher fees, however, will eat into your profits for sure.  Given the choice between two funds in the same sector of the market (large caps, international, etc…) buy the one with the lowest load and yearly fees.  Usually this is an index fund, which is unmanaged and therefore doesn’t need to pay for managers and research.

2) Spread your money out.  You will never know which sector of the market will perform the best.  Sometimes large cap stocks will do well.  Other times it is small caps.  Sometimes value investing works.  Other times it is growth and momentum investing.  The US is also not always the best place to invest – sometimes it is going well  overseas while the US is in the doldrums.  Buying into different sectors means you will never have all of your money in the hottest sector, meaning you’ll never have the maximum return possible.  Still, it does mean that you will have some money in the hottest sector at all times, which beats missing out on the best returns most of the time because you’re fully loaded into the wrong sector.  Given that you’ll never know which sector will do the best during any given period, diversification is better.

Good diversifications doesn’t just mean buying different funds since many funds will invest in the same stocks.  Instead, try to buy funds that invest in specific sectors, such as a large cap fund, a small cap fund, a mid cap fund, an international fund, an emerging market fund, and so on.  You can also add things like REIT funds to add real estate to your investment mix.  Buying a total market fund, which purchases stocks in every sector of the market, is also an option if you want to keep things simple and don’t want control over the percentages invested.  In managed funds, you should look for both a momentum (growth) fund and a value fund.

3)  Rebalance one a year.  You might diversify well but then after a few years your funds become unbalanced.  Maybe large cap stocks did much better than small caps so your large cap fund is oversized.  If there is a decline in large caps or a rally in small caps, you then won’t do as well as you would have had you been properly balanced.  For this reason, you should periodically rebalance your accounts, selling shares of those that did well and buying shares of those that did less well.  Most mutual fund companies have a way to do this with just a few clicks of the mouse.  This should done at most once or twice a year, preferably in the Spring since there is usually a rally in stocks in the winter months through the first month of the year.  You could just rebalance on your birthday or some other day you can remember.

4)  Overweight in the types of funds that perform well over time.  During the last several years, growth funds have outperformed value funds.  Over long periods of time, however, value funds come out a few percentage points ahead.  Small cap stocks have done really well over the last few years and look a little frothy at the current time, so it might not be the time to overweight in small cap stocks, but over long periods of time, small caps do better, so when they don’t look so expensive, you might want to have a slightly larger portion of smallcap stocks than largecaps.

5) Hold off on bonds until you are close to needing income from your portfolio.  The standard advise is to “buy your age” in bonds, meaning that a 30 year-old would have 30% of his portfolio in bonds.  The trouble is that bonds will return around 6-8% over long periods of time, while stocks will return 12-15%.  Why would you want to have 30% of your portfolio in something that returns about half as much for 35 or 40 years?  It is true that bonds calm down the gyrations in the value of your portfolio and that you need to start shifting into assets that will pay interest payments as you near the time when you’ll be drawing income from your portfolio since this will both provide the cash you’ll need to spend and reduce the chance that a big market downturn will devastate your portfolio, but with 15-20 years to go, it is probably better to stay in all stocks and REITs.  Building up cash to allow you to wait out a market downturn rather than buying bonds if bond yields are very low, as they are now, is also a strategy to consider.

6) Think about adding a few individual stocks.  You can’t do this with a 401k, but you can in an IRA or taxable account.  Here you’re trying to pick a company that does really well over a period of decades rather than finding a stock that will do well in any given year, so think like you’re buying into the business as a partner rather than simply trading a stock.  Worry more about fundamentals and less about the price movements of the stock.  Pick a few great growth companies, preferably the best ones in a few industries, and buy 500 to 1000 shares of each.  Make these stocks you plan to hold for decades.  If you do well with one of the companies and it becomes too large a portion of your portfolio (for example, you have $500,000 in assets and one of the companies makes up $100,000 of your total), sell a few shares and put it into additional indivdiual stocks or add to your mutual funds.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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