A core portfolio consists of large-cap stocks and index funds that don’t need constant monitoring. As a result, this part of your investment portfolio is usually passive. The main goal of the core portfolio is to generate long-term wealth and meet your investment goals by using strategic asset allocation. Speaking to an investment planner that can help will enable you to understand core portfolios better and make informed decisions.
Three Strategies For Building A Core Portfolio
You will want to keep costs down, align your investments with your values, and ensure tax efficiency when building a long-term core portfolio. The three primary strategies for building a core portfolio are passive investing, active investing, and direct indexing:
Passive Investing
Passive investing refers to funds that try to replicate the performance of an underlying index. Many index and exchange-traded funds come under this category. Passive investing today accounts for more than half of the US’s stock funds and nearly one-third of all of the US’s bond funds.
Benefits Of Passive Investing
Below are some of the benefits of passive investing:
- They cost very little, making them a popular investment strategy.
- They expose you to the investment industry’s different sectors, geographies, and segments.
- You can easily track and monitor what you own as the passive fund managers will only try to emulate an index. They won’t have to keep information on fund holdings private.
- Passive investments are tax efficient as they rarely gain capital gains payouts and don’t usually trade.
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Cons Of Passive Investing
Like all other investment strategies, passive investing also has a few disadvantages:
- It has no potential to outperform the tracked index.
- It is not very flexible and will lock you into a preset group of securities and stocks.
Active Investing
Active investing is when professional money managers handle actively managed funds and try to outperform their corresponding benchmarks. As a result, they preserve capital, generate an income, or achieve any other goal by deploying proprietary research for specific funds. Such investments are called active because of the frequent trading of such funds.
Benefits Of Active Investing
Below are some of the benefits of active investing:
- These investments let managers beat the market through rightly timed buy-and-sell decisions.
- Since active investments don’t have to follow any specific index, managers can develop solutions to align with the investors’ market views.
- Active investments let managers sell investments that are not making money to offset taxes owed on investments that are doing well.
Cons Of Active Investing
The disadvantages of active investments are given below:
- Active investments cost more as they need more management.
- Most active investment funds will be unable to keep up with the broad market, especially over long periods.
- People who manage active funds must report the holdings only once a quarter. As a result, they won’t be able to see what they own in real-time.
Direct Indexing
Direct indexing is a hybrid approach that combines the best features of both passive and active investments. It lets investors hold individual securities in an index instead of in an ETF wrapper or mutual fund. It also allows investors to use tax-loss harvesting, where you can sell off individual securities that have lost value to offset capital gains taxes. Finally, it also enables investors to customize index holdings per their needs by letting them exclude securities that don’t align with their views or values.
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Benefits Of Direct Indexing
- Since direct indexing involves opportunistic tax loss harvesting, investors can boost their after tax-returns, generating outperformance relative to the benchmark index. This lets the money that would have been used for paying capital gains tax stay invested.
- Investors can change the index fund’s holding to match their requirements and values.
- Direct investing offers the same kind of transparency as index funds and ETFs. It gives investors more control over what they own.
- Investors can enjoy the key benefits of actively managed funds but at a lower cost.
- Since direct indexing strategies employ separately managed accounts, their holdings can easily be transitioned from one custodian to another without liquidating positions.
Cons Of Direct Indexing
Below are some of the disadvantages of direct indexing:
- The minimum amount required for direct indexing can sometimes be too high, ruling out some investors
- You cannot adopt direct indexing for asset classes like commodities and bonds. It is a stocks-only option.
- Direct indexing funds are costly as they will need an active manager.
Which strategy you deploy in your portfolio will depend on your unique situation. You must consider your goals, risk capacity and tolerance, tax situation and personal values besides the cost. When hiring an asset management company, look for one that has a middle office solution that provides a scalable, technology-driven operating infrastructure. A blend of passive and active strategies may be the most useful for most investors. If you need help determining what strategy works for you, you can speak to investment managers like FBB Capital Partners. They can guide you on your core investment strategy and advise you on the best way forward based on your present situation.