Fleishman’s yeast has a recipe at their website for what they call the “master dough.” It’s slightly sweet and from it you can make dinner rolls, cinnamon rolls, fruit braids, and all sorts of other tasty treats. What if there were a master stock portfolio that you could start with and adjust to meet whatever goals you have for investing?

Todays we’re going to provide the Master Stock Portfolio. This is a base portfolio that you can tune and adjust for different needs. We’ll create it using Vanguard funds, but really you could use similar funds from any fund company or even mix and match. The point is to demonstrate how to create a portfolio of funds for your 401k, IRA, general brokerage investment account, or whatever you have and how to tune it based on your goals and personal risk tolerance. Note that this portfolio is just an example and may not be suitable for you, personally, exactly as listed. Instead, use it as a guide and to learn how to set up your own portfolio.

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Want to learn the secrets to investing and really turbocharge your returns? Check out the second book in The Small Investor series, Investing to Win. This book presents 40 years of investing experience. Someone starting with zero knowledge of investing and the stock market could take this book and learn all that they needed to invest and do well. It would also be useful to someone who has invested and traded stocks for a while but who is really not getting the kind of returns desired.

Investing to Win

The Master Stock Portfolio

Let’s start by showing what is in the Master Stock Portfolio (MSP) is, then talk about how to use it. The MSP is:

VLCAX – The Vanguard Large Cap Index Stock Fund

VEVFX – The Vanguard Small Cap Explorer Value Fund

VTMGX – Vanguard Developed Markets Index Fund

VEMAX – Vanguard Emerging Markets Stock Index Fund 

These are all mutual funds, meaning that investors send in their money and a professional money manager invests it for them as a group. This allows these investors to be invested in many different stocks without the fees and investment money it would require to buy that many stocks individually. Note that this makes it easy for the investors because they just need to choose and buy one fund instead of hundreds of individual stocks. With mutual funds there is normally a minimum you must invest to start. After that, you can normally send in money in any amount and add to your investment.

The first fund, VLCAX, is a large cap index stock fund. “Large cap” means that they invest in large companies, and these would be primarily US companies. This would be stocks like Google, Amazon, Nvidia, Bank of America, and General Motors. “Index” means that they buy based on a list of stocks designed to follow what that segment of the market is doing rather than having a manager pick which stocks to buy. This makes costs very low, increasing your returns.

The second fund, VEVFX, is a fund that invests in small cap value stocks. This is also an index fund, keeping costs low. “Small cap” stocks are small stocks, most of which you probably have never heard of. Examples you may have heard of in this fund are Yelp, Under Armour, Inc., and Mister Car Wash. “Value” means that it is stocks that are cheap compared to the perceived value of the company. These companies are much more likely to go bankrupt than any of the large cap stocks, but those that do well will grow much faster than any of the large cap companies and therefore provide a much larger return. On balance, this mutual fund will likely outperform the large cap mutual fund over long periods of time.

You hold these small stocks to benefit from their higher returns even though the risk of any one of them failing is much greater. The risk is only worth it because of the large number of stocks you hold. More fail, but those that do well, do very well, so they make up for the failing stocks.

SmallIvy Book of Investing: Book1: Investing to Grow Wealthy

The third fund, VTMGX, invests in non-US stocks. Where the first two funds are buying mainly US stocks, these look elsewhere in the world. This fund only buys in developed countries which are fairly stable and predictable. It is not likely that a coup will change the government or the state will confiscate private property. Over long periods of time, this fund should perform a lot like the Large Cap US stock fund. Because these stocks may be doing well when the US stocks are doing poorly and vice-versa, holding this fund helps to smooth out the returns of your portfolio.

The last fund, VEMAX, is also a non-US stock fund. This one, however, buys into developing countries. These are countries that are not as stable but are showing growth. The hope here is that these countries will become developed while you own the fund. Because they’re coming from nothing, there is a huge amount of potential growth that can occur. There is a lot of risk, however, that any of these companies can survive, given both an unstable economy and an unstable social environment. You’ll notice that we tend to limit how much of our portfolio is comprised of this fund.

Peanut Butter Spread

So, those are the funds in the MSP. Again, you could pick another fund family and find similar funds to use. There is nothing special about Vanguard, other than the availability of a lot of index funds. How do you use them?

One possibility would be to do a “peanut butter spread” of your money where you just put 25% of your money in each fund. As you earned new money to invest from your job, you could just keep investing 25% in each fund. This would not be an ideal investment plan for most people, but it wouldn’t be terrible either.

Good things about this plan:

1. It would spread your money out into several areas of the markets. By doing this, you’d be assured of always owning whatever is doing best at any given time. Sometimes that would be large US stocks, other times it would be emerging markets. This would also mean that when one segment was doing badly the other segments would help hold you up and keep your portfolio value from declining too much.
2. It would be really simple. You’d just be buying equal amounts, so there would not be any decisions to be made. This could be done on auto-draft very easily or through automated investments into your 401k fund.

Bad things about this plan:

1. You’re putting a large percentage of your portfolio into emerging country stocks. This is a very risky segment. It could do really well, but you could also see losses by being invested in this area, even over long periods of time.
2. Having a large portion of small value stocks would also cause large fluctuations in your portfolio. Over long periods of time this segment should actually outperform the other segments, but the changes in portfolio value might be unsettling for you.

If you’d like to learn more about how to decide how much you should put in different types of assets, Sample Mutual Fund Portfolios gives lots of information and examples of how to make allocations for all sorts of different goals, including retirement.)

Large Stock Tilt

A second possibility would be 40% in Large Caps, 25% in Small Value, 30% in Non-US Developed Country, and 5% in Emerging Markets. Here you are tilting your investments towards large companies. Both the Large Cap and the Non-US Developed Country fund would mainly be in large company stocks. These stocks would change in price less quickly than small stocks.

Advantages here would be:

1. Smaller fluctuations in the value of your portfolio. If you get nervous seeing your investments go up and down, this would make them move less overall.
2. More predictable portfolio values. While it will never be possible to know what your portfolio will do from year to year, with larger stocks you know the level of the fluctuations will be less, so future portfolio value will be more predictable, within a range.
3. More likely positive returns over shorter period of time. If you’re only investing for a five or ten years, it is more likely that you’ll see positive returns with large stocks than with small ones. Of course, over five years there will still be times when you lose money.

Disadvantage:

1. Because you’re tilting towards large stocks, your returns over long periods of time (like 20+ years) will probably be less. Small stocks will perform better if you give them enough time. Over short periods of time, either group of stocks could perform better.

That’s really the only disadvantage of tilting this way: You’ll be giving up some returns over long periods of time in exchange for more steady returns. If you’re likely to get nervous during a big downturn and sell out, this would be a better portfolio for you than one that had more small stocks and more volatility. Also, if you really get nervous, there is nothing wrong with only investing a portion of your funds and keeping the rest in bank CDs, bonds, or other more stable assets. You’re definitely giving up return by doing this, but if it keeps you from selling everything at the bottom of a big stock market fall, having some cash and bonds to balance things can be a good thing.

Small Stock Tilt

If you have a strong stomach for stock market fluctuations, you can design a portfolio to have the best chance of providing the best return over long periods of time. This would be the kind of portfolio you would create at 20 and not look at much again until you were in your 40s. You would expect there to be times when you would see a 40% decline or even more, but you would just keep investing more and letting things go. You would know that if you held on long enough, your stocks would recover and you would see positive returns. In fact, you should have the attitude that if your funds go down, you can buy more at lower prices. You would start to shift to a safer portfolio as you started to get to where you would use the money.

One such portfolio would be 25% Large Caps, 20% Non-US Developed, 45% Small Value, and 10% emerging markets. Here you are putting the most money in the segment of the market that would be likely to do the best over very long periods of time (US small value stocks). You’d also be increasing your exposure to emerging markets as well, but still keeping it reasonable. Note that this isn’t a crazy portfolio. You still have significant large stock exposure, but it is balanced against small value. You’re just leaning more towards small stocks and emerging markets.

This portfolio would have long periods where nothing was really happening. It would also have periods where it declined significantly. There would be periods, however, where it would increase dramatically. These rare large increases where your small stock funds doubled within a year or two would be where you would make most of your returns. At other times, little would be happening. If you didn’t have the stomach for the fluctuations and sold out before one of these large moves up, you’d probably make less over time holding this portfolio than you would have with the large tilt portfolio.

What kind of portfolio you build using the MSP is up to you. Most people would probably be somewhere between the large stock tilt and the small stock tilt portfolios. Some might even tilt more towards small stocks, especially if they were young and had a lot of time for their portfolio to recover should there be a big market event. It is also wise to become more conservative and increase your large stock tilt, as well as add bonds and other more stable assets, as you get closer to needing the money. For most people, this would be retirement time.

Don’t know how to invest? Check out The Smallivy Book of Investing for a great primer. It gives you all the information you need to start investing and managing your wealth.

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmalllIvy

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..