Many of us wish for less complexity in our lives. From relationships to finances, we crave simplicity.
But life doesn't really allow for that most of the time.
You're juggling your schedule to get kids to soccer games or to have a date night with your spouse.
You're trying to figure out why the dishwasher stopped working.
You're trying to make that paycheck stretch just a tiny, little bit farther than it probably ought to.
Complexity creeps into every aspect of our lives -- even though we don't want it to -- and investing is no different.
We want simplicity. So why is it so many of us have bloated, complex portfolios?
My portfolio has never been particularly complex because I'm a rather boring investor. But even I like to review the situation periodically and figure out where I could simplify matters.
Take a look at your portfolio. Does it seem complex? I'm guessing it does.
But help is available. Here are five simple reasons why you should simplify your portfolio:
1. You'll Invest In What You Know
Warren Buffett famously talks about investing within his 'circle of competence.' On a basic level, this means investing in what you know. In many cases, a complex portfolio includes investments that you might not understand. It's easy to collect the stocks of businesses you don't really 'get,' and it's tempting to pile into the 'hot' investment of the day, even when you don't know how it works. (Credit default swap investments, anyone?)
You are more likely to see solid returns over time when you can make an informed decision about your investments. Simplify your portfolio so that it only includes investments that you understand, and your long-term results will likely remain satisfactory.
2. Avoid Too Much Overlap
You know that portfolio diversity is important. However, a complex portfolio with several mutual fund holdings and a variety of assets can lead to too many of your eggs in one basket. I was surprised at one point early on in my investment efforts to find that several of the mutual funds I owned had similar companies -- or even the same companies. I was overloaded in one sector as a result.
After re-allocating my portfolio, including getting rid of many of my mutual funds in return for ETFs aimed at doing specific things, I enjoyed less complexity and eliminated much of the overlap, creating the diversity I wanted.
3. Simplicity = Long-Term Focus
When you set out to create a simpler portfolio, you are forced to shift your focus away from the short-term to the long-term. When you have fewer investments, you are forced to make sure that you are getting true value for the investments you have. In many cases, this requires that you adopt a long-term perspective.
With an investment strategy focused on the long haul, you are more likely to be able to 'set it and forget it,' creating a situation in which you can use automatic investments and dollar-cost averaging to build long-term wealth. While you will need to re-balance occasionally, a simple portfolio doesn't need much fiddling in the short-term, and you can let things take their natural course.
4. It Is Less Work For You
When you have a complex portfolio, you have to stay on top of things. Blips in the stock market worry you. You need stop-loss orders to prevent your losses from piling up too rapidly before you can trade. Active trading requires adherence to daily (or even hourly) charts.
When you pare your portfolio down to a few key ETFs or index funds, you have a lot less work to do. You don't need to trade as frequently or do as much research. A little rotation in your portfolio on occasion, or some rebalancing, is all you need.
A simple portfolio can provide you with peace of mind as well. You don't have to stress about short-term market volatility when you have a simple portfolio focused on the long-term. I rarely lose sleep over huge stock market drops. With my simple portfolio, I know that, eventually, I will likely come out ahead. Plus, when the market is down, my dollar buys a lot more.
5. You'll Save On Fees
A complex portfolio is expensive. Frequent trading means more transaction fees. A large number of actively managed mutual funds means higher expense ratios. Various 401(k) fees can drain tens of thousands of dollars from your portfolio over a lifetime. Can you imagine if all your investments had high fees that were eroding your real returns? Your potential losses could be huge.
Simple portfolios cost much less. When you have a simple portfolio, you can use ETFs with expense ratios of less than 0.5% -- and even as low as 0.04%. Also, a simple portfolio doesn't require a great deal of active management. You'll engage in few transaction fees and pay lower commissions.
The Investing Answer: Your simple portfolio is a lot less work, and it will likely cost you a lot less. You might not see amazing gains with a simple portfolio, but you will probably build more wealth over time and do it without stressing out every time the stock market drops.
