How To Build Your Mutual Fund Portfolio

A portfolio is simply an investment or group of investments designed to maximize returns while minimizing risk. A mutual fund portfolio is the same thing, an assortment of mutual funds designed to maximize returns based on your personal risk tolerance. To get started planning YOUR mutual fund portfolio:

  1. First, evaluate your personal risk tolerance.
  2. Next, decide your asset allocation.
  3. Then, allocate your cash.

Risk Tolerance

Risk tolerance is your ability to handle (tolerate?) the inevitable declines in the value of your investments (no one needs “help” handling increases!). Risk tolerance is not actually a quantifiable figure but is instead a subjective evaluation that depends on both practical and personal factors:

1. Your available funds

Only invest money you don’t need to cover your everyday bills and expenses (or anticipated expenses, like upcoming medical bills, college expenses, etc). The less you “need” the money you’re investing, the higher your risk tolerance.

2. Your investment time horizon

Risk tends to decrease the longer you hold on to your investments. The shorter your time horizon—the amount of time you expect to hold your investments—the lower your risk tolerance.

3. Your personal aversion to risk

Do you have a tendency to avoid risk … or seek it out? The more you can stomach risk, the higher your risk tolerance will be in terms of investing and the higher the potential reward.

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Over longer time periods, risk and reward typically go hand-in-hand: the greater the risk you can tolerate, the greater your possible rewards. Based on your available funds, time horizon, and risk aversion, you can decide how aggressive or conservative your ideal mutual fund portfolio should be.

  • Aggressive – Accepting bigger risks for the long-term potential of bigger rewards
  • Moderate – Limiting risk somewhat while also limiting potential reward somewhat
  • Conservative – Limiting risk while also limiting potential reward

Asset Allocation

Asset allocation is the process of buying various types of stocks, bonds, mutual funds, ETFs, or other securities in order to create a diversified investment portfolio. The relative risk and reward of a mutual fund generally depends on security type it holds. Based on the different risks associated with different types of funds, you can allocate your assets across different funds to make sure that your investment is exposed to the right amount of risk (and potential reward) for your personal financial situation.

investment risk vs reward chart

Types of Mutual Fund Accounts

When building your mutual fund portfolio, consider the type of account in which your mutual fund investments will be held. There are three main types of accounts:

  1. Tax-deferred
  2. Tax free
  3. Taxable

You can hold mutual funds in just one type, or all three. The type of account in which you choose to hold each fund should depend on the tax advantages of the account and the tax-related traits of the fund, as explained below.

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Tax-Deferred Accounts

With tax-deferred accounts, investors are allowed to delay paying taxes on investments they’ve made for specific purposes, such as retirement. The most common type of tax-deferred account is the traditional IRA. If you own mutual funds in a tax-deferred account such as a traditional IRA, you won’t pay taxes on the interest or dividends that the fund pays, or on the capital gains taxes the fund incurs, until you begin withdrawing from your account, usually after age 59 1/2.

Tax-Free Accounts

Tax-free accounts let you make after-tax contributions into investment accounts that can then grow tax-free. The three most popular types of tax-free accounts are Roth IRA, 401(k), and 529 accounts (college savings).

Taxable Accounts

Most general investment accounts are taxable accounts, which offer no special tax advantages.

Where to begin building your mutual fund portfolio

  • optionsXpress – one of the easiest online brokerages to set up. No paper forms or signatures required.
  • E*Trade – over 1,000 NO LOAD, NO FEE mutual funds available
  • TradeKing – offers regular trades and broker assisted trades for only $4.95.
  • tradeMonster – offers mobile trading.
  • optionshouse – this is basically the least expensive online brokerage for  investors.
  • Zecco – has commission free trades available.

About the author

Ron Haynes has written 1091 articles on The Wisdom Journal.

Ron is the founder and editor of The Wisdom Journal. He has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a partner in a national building materials company.

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