How to Build a Great Investment Portfolio with Low Cost Funds

If you are looking for an instant diversification as you work to grow your wealth, a mutual fund (or an ETF) can be a good way to proceed. With either types of fund, you buy shares of several underlying investments at once, because a fund is a collection of investments (so when you invest in a fund, you actually invest in all of what the fund holds).

Mutual funds and ETFs make it fairly easy to diversify. You can diversify across companies or sectors, and you can even invest in the entire market, just to make sure you have a piece of everything. Funds also include investments beyond stocks; you can invest in bonds and more with the help of mutual funds and ETFs.

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As with all investments, though, there is a cost associated with investing in mutual funds and ETFs. When you buy shares, you will likely be charged a transaction fee, which is dependent on the brokerage firm that you use. Even if you aren’t charged a transaction fee (i.e., when you invest in a no transaction fee fund), you will need to pay a percentage of your invested money in the form of an expense ratio. This is a fee you pay based on the value of your holdings, usually a percentage. You might also be charged sales loads when you buy or sell shares in the mutual fund.

These costs can start to add up if you aren’t careful, eating into your returns, and reducing your ability to build wealth at the rate you would like.

Keep Your Costs Down

If you want to keep your costs down, you need to carefully compare your options. Here are some things to pay attention to as you choose a low cost fund:

  • Expense ratio: Many mutual funds, and some ETFs, have expense ratios of around 1% a year. However, there are funds out there with lower expense ratios, even ones with expense ratios of less than 0.5%. The lower the expense ratio, the more of your own money you keep.
  • Loads: Watch out for load fees. These mutual fund fees might be charged when you buy, and it’s even worse when they are charged when you sell. Look for a fund that is “no-load.” You’ll still have to pay other fees, but you won’t have to worry about the load fee.
  • Turnover: All funds have turnover as some investments are sold and new investments bought to replace them in the fund’s holdings. Depending on the circumstances, and the type of account that your fund is held in, it’s possible that you will face tax consequences due to turnover. Plus, turnover can result in other fees. Pay attention to the rate of turnover as you look for a low cost mutual fund.

One of the best ways to keep down costs is to consider an index fund. An index fund is a type of mutual fund or ETF that tracks the performance of a specific index. It’s possible to find funds that track the entire US stock market, or that are limited to smaller indexes, like the Russell 2000. You can find funds that track foreign indexes, and even bond indexes.

Actively managed funds are problematic due to high fees. Even though some managed funds can beat the market, once you factor in the fees, very few managed funds actually beat the market. Even though index funds often lag their indicators, the reality is that their lower costs mean that investors have the potential to see better overall returns in many cases.

Consider Your Goals

Now that you have identified ways to keep your costs low, you need to figure out which low cost fund — or funds — to add to your portfolio. Before you invest, it’s a good idea to consider your goals and your investment strategy. It’s possible to use low cost funds to create a portfolio that is diversified across asset class, geography, and sector.

Look at your risk tolerance and your asset allocation. Most brokers offer a variety of low cost options that can fit your needs, whether you are looking for growth, income, or capital preservation. Choose a mix of funds that will help you reach your goals and improve your portfolio.

Low Cost Mutual Funds and ETFs Portfolios

Here are a few examples of how you can put together a well diversified portfolio using mutual funds and ETFs.

Target Retirement Fund

For beginners, this is by far the easiest way to invest. Target retirement funds are turnkey solutions to your retirement investment needs. You basically have to pick the closest retirement year, e.g., if you’re turning 65 in 2030, you could invest in a 2030 fund. Some of the lowest expense target retirement funds include:

3 Funds Portfolio

Another common approach is to invest in 3 low cost funds consisting of a US stock fund, a International stock fund, and a bond fund. Bogleheads.org has a good explanation and a few examples. For example, a portfolio built with Schwab funds:

In additional to these examples, you can build your own portfolio using a tool like Personal Capital. With it, you can either analyse your current investments and trade out expensive ones for lower cost ones; or build a brand new one and use Personal Capital to project the expense for you.

About the Author

By , on Apr 14, 2013
Miranda Marquit
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.

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Leave Your Comment (2 Comments)

  1. Bryan@Fatwallet says:

    After my 401k and Roth IRA, I am all about the ETFs. As pointed out, Vanguard and Schwab both offer some very low cost ratio products. :)

  2. Roger @ The Chicago Financial Planner says:

    Many good suggestions Miranda.

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