Follow These 20 Rules To Build a Strong Portfolio By Jonathan Clements The Wall Street Journal If you're trying to pick up the pieces, pick carefully. The bear market may be over. But many investors are a long way from recouping their losses. Looking to hasten your portfolio's recovery? No doubt you are anxious to avoid further foolish mistakes. To that end, be sure to follow these 20 rules of portfolio building: 1. Those who amass impressive portfolios are sometimes good investors. But they are almost always prodigious savers. Socking away a healthy sum every month is the surest way to make your financial accounts grow. 2. Before deciding what to buy, consider when you will sell. Stocks may be your best bet for earning high long-run returns. But if you are within five years of needing your money, you can't afford the risk involved. 3. Your attention will inevitably be drawn to the results for each of your investments. But what really matters is the performance of your entire portfolio. 4. For long-term investors, the big threats are inflation, investment costs and taxes. If your returns aren't high enough to beat back those three threats, you aren't making any money. 5. Your stock-bond mix is almost always an unhappy compromise. You should put enough in stocks to generate the sort of long-run returns you need, but not so much that you become unnerved next time the market tumbles. 6. If you're a long-term investor, you shouldn't have all your money in stocks or all your money in bonds. Stocks and bonds often move in opposite directions, so you can reduce your portfolio's volatility by owning both. No matter how squeamish you are, don't put less than 20% of your portfolio in stocks. Similarly, no matter how aggressive you are, don't let your bond holdings drop below 10%. 7. Once you decide what percentage of your portfolio you want in stocks, look to rebalance back to this percentage at the end of each year. That will force you to buy stocks in market declines and lighten up when stocks are roaring ahead. 8. In divvying up your portfolio among various stock and bond sectors, an unswerving commitment is much more important than the precise mix. Some experts suggest stashing 10% of a stock portfolio in foreign stocks, while others advocate 40%. But within reason, the exact amount is less important than your willingness to stick with your chosen percentage through thick and thin. 9. Buying risky assets can lower your portfolio's risk level. On their own, gold stocks, high-yield junk bonds and emerging markets are enormously risky. But if you add a sliver of these investments to your portfolio, you can actually reduce your portfolio's overall risk, because these investments may post gains when your core stock and bond holdings are suffering. 10. Whenever a market falls in value, you should become more enthusiastic, not less so. Individual stocks and bonds may lose all value. But it is rare that entire markets disappear. To be sure of capturing a market's performance, buy mutual funds, not individual stocks. 11. Never buy an actively managed stock fund unless you are confident it will outperform competing index funds. With my own portfolio, I find it hard to summon that sort of confidence, which is why I have almost all my money in market-tracking index funds. 12. The quickest way to get poor is to bet everything on one stock. The quickest way to get really poor is to bet everything on your employer's stock. Just ask the laid-off employees of WorldCom (now called MCI), Enron and other troubled corporations, who lost both their paychecks and their nest eggs. 13. When you buy an investment, you never know whether you have yourself a winner. But if you hold down costs, you will definitely improve your results. Indeed, trying hard to outperform the market is almost always self-defeating. The more you trade, the more you incur in investment costs, thus making it less likely you will beat the market. 14. The biggest investment cost is taxes. To slash your portfolio's tax bill, max out your 401(k), fund your individual retirement account and trade with great reluctance in your taxable account. 15. If you keep costs low and maturities short, you won't go too far wrong with bonds. Short-term bond funds will give you much of the yield of longer-term bond funds, but with a fraction of the price gyrations. But which funds should you buy? It's tough for a bond manager to overcome high annual expenses, so your top fund-picking criteria should be cost. 16. If you are at a loss for what to buy, consider purchasing either inflation- indexed Treasury bonds or Series I savings bonds. They are probably the closest you will ever get to a risk-free investment. There is no credit risk, because the bonds are government-backed, and there is no long-run inflation risk, because the bonds offer a fixed yield above inflation. 17. Paying down debts is like buying bonds. When you buy bonds, you lend money to others, in return for which you earn interest. By contrast, when you pay down debts, you reduce the amount you owe to other folks and thus reduce the amount of interest you have to pay. Paying off credit cards and other high-cost debt is one of the smartest investments you can make. Depending on your mortgage's interest rate, it can also make sense to make extra principal payments on your home loan. 18. The biggest gain from homeownership doesn't come from price appreciation. Instead, the big gain comes from the rent or, if you live in your own home, the imputed rent. One implication: You shouldn't expect huge profits if you buy a vacation home and then use it yourself, rather than renting it out. 19. If you want to invest in real estate, I would forget buying actual properties and instead purchase real-estate investment trusts. With REITs, you will get the sort of returns enjoyed by real-estate owners, but without the hassles of being a landlord. 20. For the sake of your sanity and your heirs, keep your portfolio simple. Draw up a list of all your investments. If the list doesn't fit on one page, you own too many investments.