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Course 106
Core vs. Noncore Investments


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.

A core holding is just what it sounds like: It's the central part--or maybe even the only part--of your portfolio. The core requires investments that will be reliable year in and year out. They're the solid foundation for the rest of a portfolio.

Once you’ve built your portfolio’s core, you can then reach for noncore investments to augment those core holdings. Noncore investments might focus on an individual sector, such as health care, or a single region, such as Latin America. Because they’re more focused, noncore investments have the potential to increase returns, but they may also jack up a portfolio’s volatility level.

What Makes a Core Mutual Fund?

The stock market is dominated by large companies; such firms account for roughly three fourths of the value of the U.S. market. Assuming that you’d like your portfolio to participate in the movements of the broad U.S. market, as opposed to just a small sub-section of it, you’ll want to use a large-company-focused fund as your core stock holding.

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, a conservative large-value fund may be an even better option. These funds invest in big, well-established companies with stocks that are cheap relative to those of other large caps; they may also focus on dividend-paying firms. Historically, that focus on slow-growing, generally steady companies has earned large-value funds the lowest risk scores of any of the Morningstar style categories.

But wait. If large-cap funds are good core holdings, why not large-growth funds? These funds typically focus on large companies with the potential to grow more rapidly than the broad market.

Although there are exceptions, 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 at certain points in time--but when they're down in the dumps, that spells bigger losses than you might want at the heart of your portfolio.

If the allure of large-growth funds is just too powerful, go ahead and invest in one. But invest in an equal amount of money in a large-value fund, too. Owning both is about the same as investing in a large-blend fund.

You might want to include a foreign-equity fund as a core holding, too. 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. Before investing in a foreign fund, be sure to take Funds 305: Choosing an International Fund, Part 1 and Funds 306: Choosing an International Fund, Part 2.

Finally, a bond fund might make a good core holding if your asset allocation calls for it. Stick with bond funds that invest in high-quality securities. Focus on those that favor intermediate-term bonds. Why? Because the longer a fund's maturity, the more volatile its returns generally are. You can capture much of the return of a long-maturity fund with an intermediate-maturity fund, but with a lot less volatility.

Before investing in a bond fund, be sure to take Funds 307: Examining a Bond Fund's Portfolio, Part 1 and Funds 308: Examining a Bond Fund's Portfolio, Part 2.

What about Core Stocks?

If you're more into stock investing, your core should be made up of stable, blue-chip companies. As with funds, big and boring is the key to a core investment.

Great core stocks share a handful of qualities. For starters, they're profitable, consistently earning great returns on the money (or capital) shareholders have invested. The way we measure return on capital for companies is return on equity, or ROE. It's easy for a company to generate a large ROE in one year, though. Core holdings offer impressive ROEs year in and year out.

Core stocks are reliable growers. They may not be growing at the same pace that a new company is. But their earnings are predictable year in and year out, and they may even pay out earnings to shareholders in the form of a dividend.

Finally, core companies are also financially healthy. In other words, they don't take on a lot of debt. Moreover, they generate gobs of free cash flow, or cash flow after spending.

You can find many great core stocks among Morningstar's classic-growth stock type (particularly those that Morningstar has also rated as having "wide" economic moats, which is how we designate firms that have sustainable competitive advantages). These types of companies have mature and solidly profitable businesses. You can learn more about classic-growth stocks on

How Big Your Core Should Be

Clearly, a fund that is a core holding for one investor may not be a core holding for another investor. However, Morningstar analysts do discuss what role a fund may play in a portfolio--core, supporting, or specialty--in the Analysis section of a Morningstar Fund Report. (Note that Morningstar Analyses are available only to Premium Members. Nonmembers can take a free trial of's Premium Service.)

Core holdings take up 100% of some portfolios. In others, these investments account for 70% to 80% of assets. There's no rule for how large your core ought to be. But we suggest that core holdings take up at least two thirds of your portfolio. After all, you are relying on these solid, long-term investments to help you reach your goals.

Use noncore investments for diversification and growth potential. For instance, if your core is made up exclusively of large-cap stocks, you might want to add small-cap or international stocks to the noncore portion of your portfolio for diversification.

As long as you limit the more risky portion of your portfolio, you aren't likely to threaten the bulk of your nest egg--and your investing will be more adventurous.

Just don't forget to put together a reliable core first. You don't want more thrills than your portfolio can stand.

Quiz 106
There is only one correct answer to each question.

1 Which is the quality of a great core holding?
a. It outperforms everything else in a given year.
b. It's very risky.
c. It's boring.
2 Should a bond fund be a core holding for you?
a. Yes. Everyone should own bonds.
b. No. No one should own bonds.
c. Maybe. It depends on your asset allocation.
3 Which of the following would make the best core holding for most investors?
a. A large-blend fund
b. A large-value fund
c. A large-growth fund
4 Which of the following would make a good core stock holding?
a. A large-company that's financially strong and growing at a steady rate
b. A mid-sized Internet company with no profits
c. A small company that's growing at 30% per year
5 How big should your core be, at the very least?
a. 25% of your portfolio
b. Half of your portfolio
c. All of your portfolio
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