What a core holding is and what it can do for you.
By Peter Di Teresa | 07-14-00 | 06:00 PM | Email Article
Many of the questions I get are variations on "Should I do X or Y with my portfolio?" It's the sort of question I often ask myself. What matters more than anything else, though, is having a solid foundation for your portfolio. This column from March addresses just that point.

Dear Professor,

Periodically in a Morningstar Fund Analysis, I read that a fund would make a good core holding. What does Morningstar mean by a core holding? What percentage of a portfolio should be in core holdings?

Ann C.

I'm so glad you asked. The core-holding concept has to be one of the most exciting investing ideas since Christopher Columbus started cold-calling potential backers. Okay, that's sarcasm. Core holding and exciting don't go together. But what core holdings lack in thrills, they make up for in importance. When Morningstar.com financial planner Sue Stevens warned of the top 10 mistakes investors make in their portfolios, lack of a focused core came in at number two. To reach your investment goals, your portfolio needs a solid, reliable core. The rest is often frills.

What Makes a Fund a Core Holding?
Peter Di Teresa is a senior fund analyst with Morningstar.
A core holding is just what it sounds like: It's the central part of your portfolio. The core requires funds that will be reliable year in and year out. They're the solid foundation for the rest of a portfolio. Large-cap blend funds, which own big companies with middle-of-the-road stock prices, are core stalwarts. Large-blend funds usually don't lead performance lists, but they're even less likely to bring up the rear. They're boring, which makes them ideal core choices.

For cautious investors, large-value funds used to be the preferred core holdings. These funds invest in big, well-established companies with stocks that are cheap relative to those of other large caps. Historically, that focus on slow-growing, generally steady companies earned large-value funds the best risk scores of any of the Morningstar style categories. But not lately. Investors have been down on value stocks in recent years, and in down markets, value-oriented funds have lost more money than their blend counterparts have. I'd expect value funds to return to their long-term reliability, but large-blend funds, which buy the broader market, may be more reliable. If you're worried about risk, add bonds to the mix. (See "Why Bother with Bonds?")

But wait. If large-cap funds are good core holdings, why not large-growth funds?

Large-growth funds don't have the best temperament for core holdings; they tend to have bigger mood swings than their blend or value counterparts. Their highs are nice--they mean higher returns--but when they're down in the dumps, that spells bigger losses than you might want at the heart of your portfolio. Large-growth funds have had a powerful boost from enthusiastic technology investors in recent years, so their risks often are hidden. But the average large-growth fund has 40% of its assets in technology stocks and a three-year standard deviation of 27.84, compared with the average large-blend fund's 25% tech weighting and 20.41 standard deviation. The heavier sector weighting and higher volatility are warning signs.

You might want to include a foreign-equity fund as a core holding, though. That way, you aren't staking everything on the U.S. market. The fund should focus on the world's developed markets, investing in leading companies, just as your core U.S. funds do. As I discussed in "Uncover Hidden Fund Risks", be sure the fund has moderate weightings in emerging markets and individual countries.

To find good core choices, browse the Fund Analyst Picks.

How Big Should Your Core Be?
Sue Stevens recommends that your core holdings take up at least 50% of your portfolio. In many portfolios, they account for 70% to 80%. In fact, because core holdings are meant to be solid, long-term investments, they could comprise your entire stock portfolio. But where's the fun in that? That's where noncore funds come in.

Noncore funds are the holdings that spice up your portfolio and could perk up its returns. These are investments such as sector, emerging-markets, and small-company funds, which can win big but are also risky. Put together a reliable core and then get adventurous. Maybe you see a rosy future for everything wireless and want to buy a communications fund. Or you see a lot of potential in the world's developing areas and would like an emerging-markets fund. These are your exciting investments, but with a solid core backing them up, you won't get more thrills than your portfolio can stand.
Securities mentioned in this article



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Peter Di Teresa does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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