Investors of all persuasions might find these top picks of use.
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By Christine Benz | 12-07-10 | 06:00 AM | Email Article

Question: I have been trying to streamline and upgrade my portfolio, so I appreciated your recent article about what constitutes a core holding. But can you name some favorites?

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

Answer: As I noted in my article, there's no clear-cut definition of what constitutes a core holding. An investment that may be a perfectly legitimate linchpin holding for one investor, such as the aggressive bond fund  Loomis Sayles Bond , might be far too volatile, and decidedly noncore, for another.

A key first step, then, in finding the right core holding for you is to consider what type of investor you are. Do you like to get your hands dirty overseeing your investments, or are you comfortable outsourcing your asset management to a professional? Are you a believer in the long-term benefits of an indexing approach, or do you believe that hands-on security selection has the power to beat passive management?

What follows are a few key investor profiles, followed by appropriate core holding ideas for each. Many investors may choose to mix and match investments from each of these bins.

The Delegator
Are you looking to create a sane investment mix with few moving parts to oversee on an ongoing basis? Is your ideal holding period, like Warren Buffett's, "forever"? If so, the right core holding for you is apt to be an investment that includes a lot of diversification--in terms of asset class, geography, and investment style--under the hood of a single vehicle.

Target-date funds are the ideal vehicles for set-it-and-forget-it types, in that they aim to deliver an age-appropriate asset-allocation mix that gradually gets more conservative as the investor nears retirement. Of course, not all of these funds are worthwhile: Some featured too-aggressive asset allocations coming into the bear market, which led to outsized losses for shareholders who were nearing retirement. Others, meanwhile, simply don't have the raw materials necessary to be topnotch all-in-one offerings; namely, they lack standout offerings in all of the major asset classes. But a few target-date series tick all the boxes: Vanguard's target retirement funds (middle-of-the-road stock/bond mixes) and T. Rowe Price's Target Retirement offerings (more equity-heavy asset allocations) are Morningstar analysts' favorites.

The Asset Allocator
Would you like more hands-on oversight of your asset allocation than a target-date fund affords? Are you seeking to assemble a portfolio of very low-cost investments?

If so, broad-market index funds and exchange-traded funds make ideal core-holding building blocks for your portfolio; you can then customize your allocations to suit your own needs. (I've often recommended using Morningstar's Lifetime Allocation Indexes as a starting point for that important part of the investment decision-making process.) Index funds and ETFs give investors a high level of control over their asset mixes. There's no chance that a domestic-stock ETF will suddenly show up with 20% in cash, and a small-cap index fund won't begin buying large-cap stocks. And thanks in part to the advent of very low-cost ETFs, index-fund and ETF purveyors have been vying for cheapest index-fund rights for the past several years, slashing expense ratios and also cutting out brokerage charges for ETF trades.

On the domestic-stock front, Morningstar's large-blend category is the place to go for broadly diversified total stock-market index funds and ETFs; our analysts' core index pick is Vanguard Total Stock Market, available in both conventional  mutual fund  and  ETF  format. For broad international-stock exposure via index funds,  Fidelity Spartan International Index ,  Vanguard Total International Stock Market Index , and  Vanguard FTSE All-World ex-US , an ETF, are the favorite index funds of Morningstar's analysts. For core fixed-income exposure, Morningstar's analysts recommend Vanguard Total Bond Market Index, available in both conventional  mutual fund  and  ETF   formats, as well as  iShares Barclays Aggregate Bond .

The Active Management Enthusiast
Do you believe in the power of active managers to beat their benchmarks? Do you have the patience to stick with truly active managers through what will be inevitable weak patches? Are you comfortable with the fact that your portfolio--and in turn its performance--will at times be out of step with the broad market?

Morningstar's Fund Analyst Picks feature a number of the aforementioned index funds, but they also include many topnotch active funds. Among our team's longtime favorites are  Sequoia ,  Oakmark  and  Oakmark Select ,  Fairholme , and  T. Rowe Price Equity-Income . Active international offerings can also serve as worthwhile core holdings;  Dodge & Cox International ,  Scout International , and  Harbor International  rate among the analysts' "best ideas." On the fixed-income side, the teams at  PIMCO Total Return ,  Harbor Bond  ,  Dodge & Cox Income , and  Metropolitan West Total Return  have all demonstrated a strong aptitude for beating their benchmarks over time.

The Taxable Investor
If you're building a portfolio for a taxable account, you'll need to be more choosey than when you're selecting investments for an IRA or other tax-sheltered vehicle. You'll be on the hook for dividend and capital gains taxes on an ongoing basis, so it pays to focus on funds that have the ability to reduce the tax collector's cut of their returns on an ongoing basis.

My recent article series that highlighted tax-efficient model portfolios for retirees featured core tax-efficient holdings. My model portfolios featured tax-managed funds such as  Vanguard Capital Appreciation  and  Tax-Managed International  on the equity side, primarily because of their ability to adjust their strategies to adapt to current tax policy. But broad-market index funds and ETFs are also solid core options with a history of good tax efficiency (see the "Asset Allocator" section above for a few favorites). On the fixed-income side, Morningstar's Fund Analyst Picks in the  short- and  intermediate-term municipal national categories make worthwhile core holdings; the muni lineups from Fidelity and Vanguard are hard to beat.

See More Articles by Christine Benz

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