Our director of financial planning answers your portfolio questions.
By Sue Stevens, CFA, CFP, CPA | 07-07-05 | 06:00 AM | Email Article

For this edition of Reader Mailbag, I am fielding questions about maximum levels of portfolio overlap, how to gain access to funds with high minimum investment amounts, the ongoing value of bonds, and fixed-income diversification.

Sue Stevens, CPA, CFP, MBA, and CFA Charterholder, runs her own financial planning firm, Stevens Portfolio Design, and manages over $100 million in assets.

Limiting Stock Intersection
As I continue to build and maintain my portfolio, I am concerned about stock intersection. Is there a recommended percentage of overlap that I should strive to stay below?

I usually target 10% as a high watermark for any one stock. Most of the time, I'll be below 5%. But sometimes when someone has a large percentage of company stock, we have to gradually move toward those lower targets. The higher the percentage, the more risk you are assuming.

Circumventing High Minimum Investments
I've noticed that you sometimes write about institutional funds like Dimensional International Small Cap Value  . When I've looked them up through Morningstar Quicktakes, I see minimum investments of $2,000,000...not exactly affordable for most of us. How are these funds available?

These types of funds are available with much lower minimums (usually a couple thousand dollars) if you are working through an advisor. But not all advisors can offer these funds. Typically the advisor must be approved by the fund company to be able to purchase those institutional share classes. The advisor would purchase these funds through the custodians they have master accounts with. Advisors are also free to negotiate lower brokerage fees with custodians (like Schwab, Fidelity, and T.D. Waterhouse).

Questioning the Value of Bonds
Everything I have been reading suggests that because of anticipated increases in interest rates, bonds will lose value in the future. We have approximately 30% of our retirement portfolio in bonds and will be retiring within the next several months. Does that high of an allocation still make sense?

Just because interest rates are rising doesn't mean you shouldn't own or hold bonds. With a little bit of detective work, you can figure out about how much your bonds are likely to decrease as interest rates rise. By holding shorter-term bond funds, you can minimize losses in your portfolio. Read Bond-Fund Basics to learn how to determine a bond's duration--the key to knowing how it will react when interest rates change. If you hold bond funds, you may see your interest increase as rates rise. This increase in yield may help make up for any loss in value.

Right now, my advice is to know what you own. Check the length to maturity or the duration of your bonds. Try to stay shorter term (five years and under). Avoid most long-term bonds (10 years and over) for now. Once interest rates have stabilized (perhaps early next year), consider moving from shorter-term bonds to intermediate-term bonds (five to 10 years until maturity) to increase your yield.

While I can comment on why you should hold bonds in your preretirement portfolio, I can't comment on whether allocating 30% of your assets to bonds is appropriate. Depending on your risk tolerance and time horizon, that may be too little, too much, or just right.

Diversifying Fixed-Income
I am seeking to obtain a reasonably good return from fixed income with limited downside risk. I am presently diversifying my retirement portfolio's fixed income among the following fund categories (and I provide examples of an actual fund for each category). I will hold enough to cover annual retirement payments for seven to 10 years and update the portfolio distribution annually.

Multi-Sector -
 Loomis Sayles Bond 
Global Bond -  Loomis Sayles Global Bond 
Government -  Vanguard Total Bond Market Index 
High Yield - Fidelity High Income 
Emerging Markets -  Driehaus Emerging Markets Growth 
Real Estate -  Cohen & Steers Realty Shares 
Convertible Securities -  Vanguard Convertible Securities 
Money Market Fund - Keep a full year's worth of drawdown

Am I missing any important categories of income funds?

Note: The rest of my funds are "best of class" and equally divided
among large-, mid-, and small-cap domestic-equity funds (growth, blend,
and value), and international-equity funds (large-cap, small-cap,
emerging-markets, and regional funds).

Sounds like you've given a good deal of thought to how to structure the fixed-income portion of your portfolio. I do have some observations for you:

  • Vanguard Total Bond Market Index is not a government-bond fund. About 35% of it is in U.S. Government Treasuries and Agency bonds. That total does not include any inflation-linked bonds. Another 36% is in mortgage bonds, 22% is in corporate bonds, 2% is in foreign bonds and the rest (about 5%) is in a mixture of other fixed vehicles.

    If you just want a government-bond fund, consider two Morningstar Analyst Picks:  Vanguard GNMA  or  Vanguard Inflation-Protected Securities . The GNMA fund invests only in pass-through Ginnie Mae mortgages. There may be a bit more risk involved in GNMAs in a rising interest-rate environment. For more, see Why is Jack Bogle Avoiding GNMAs?

    Vanguard Inflation-Protected Securities invests in Treasury Inflation-Protected Securities (T

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Sue Stevens, CFA, CFP, CPA has a position in the following securities mentioned above: VIPSX Find out about Morningstar's editorial policies.
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