Conservatism is in the eye of the beholder, but a few “rules” can help someone build a conservative investment portfolio.
Conservatism generally follows a short-term need for funds. Seniors have conservative investment portfolios because they will withdraw funds each year to buy essentials. 20-somethings saving for a home use conservative savings accounts or CDs because they intend to use the funds for a down payment in the future.
Let’s look at a few conservative investment portfolios for a few different scenarios.
Best conservative portfolios
I’ll create a few portfolios to center around some important life events. Let’s use investing for college and conservatively investing for retirement as two possible scenarios.
Saving for college
You’re the proud parent of a new son or daughter. You know that raising a child is costly, and one of the biggest expenses to pay for is an eventual college education for your children. Since college costs rise well-above the rate of inflation, you want to be sure that what you put aside can keep up with the cost.
So how should you plan to save and invest for a child’s college costs? If your son or daughter is young, you have some time to take risk. A 2-year-old won’t go off to university for quite some time, so you could use a combination of stock, bonds, and cash for a model portfolio.
Here’s what you might want to consider:
- Stocks – 40%
- Bonds – 40%
- Cash (CDs) – 20%
For stocks, consider an index fund built on the S&P 500 like the SPDR S&P 500 ETF (SPY). For your bonds, look for a target maturity fund like iShares 2023 Investment Grade Corporate ex-Financials Term ETF (IBCE), which holds bonds that will mature in 2013. For cash, a one-year CD will suffice, since it will mature just in time for you to rebalance your portfolio each year.
Annual rebalancing of this fund will offer a good mix of risk and potential reward for an expense that will come 18 years in the future.
Conservative retirement investments
20-somethings shouldn’t be too conservative when investing for retirement. Since retirement is likely 40 or even 50 years away for most 20-somethings, you can afford to accept greater ups and downs in your portfolio in exchange for higher expected returns.
However, if you’d prefer to scrimp and save more money to negate lower investment returns, you can build a portfolio for that. We’ll borrow the framework from a post on how much risk young investors should take.
A good conservative portfolio allocation would be:
- 40% US Stocks
- 15% Foreign stocks
- 10% Dividend-paying US stocks
- 35% Bonds
To create this portfolio, you could put 40% of your portfolio into Vanguard’s Total Stock Market Index Fund (VTSMX), 15% into Vanguard’s FTSE All-World ex-US Index Fund (VFWIX), 10% into the SPDR Dividend ETF (SDY), and 35% into Intermediate-Term Bond Index (VBIIX).
This portfolio is slightly more conservative than a basic, model portfolio for younger savers in a post on risk. U.S. stocks and foreign stocks were reduced by 20% and 5%, respectively. Dividend paying U.S. stocks were added at 10% because they are less volatile and offer higher income potential to negate the effects of a falling stock market. Finally, bonds were increased from 20% of the portfolio to 35% of the portfolio.
This is about as conservative as most 20-somethings could afford to be in their retirement portfolios without sacrificing returns. One should also rebalance this portfolio annually.
Never be too safe
Being too safe is just as risky as being too risky. For example, it would be nearly impossible to save for the college expenses of a child or retirement by stuffing money under your mattress. Avoiding all risk will only mean that you fall behind or cannot save enough money to keep up with inflation.
History provides us with some meaningful information about the future. Look under the heading “Diversification for Fund Investors” in a post on diversification to see how changing your mix of stocks and bonds had an impact on historic portfolio returns.
A less risky portfolio may appear attractive, but one must consider another risk: the risk your returns are not high enough to meet your goals. There’s no such thing as a free lunch – higher risk brings higher reward.