What You Need to Know About Model Portfolios
When it comes time to make dinner, I don’t mind cooking a steak the way I like it. It’s not too difficult and doesn’t take up much of my time. The potatoes, however—for those, I reach for the instant stuff. This might be controversial, but I think they’ve gotten pretty good over the years. Best of all, I can pick the flavor profile I want and get what I need with little effort.
Model portfolios work much the same way. Strained metaphors aside, these pre-built portfolios offer a quick-pick option for those interested in investing without the time required to research and plan.
With the trend of model portfolios on the rise, I think it’s important to talk about things you should consider before diving in.
What is a model portfolio?
A model portfolio is a pre-built set of investments usually comprised of mutual funds, ETFs (Exchange-Traded Funds), or index funds. Funds like these tie your investments to the stock market without necessarily investing in any stocks.
Financial advisors, market strategists, or investment managers might offer model portfolio options. Because the portfolios are premade, they likely provide a few options, each designed with a different balance of assets to meet specific goals.
Why is balance important?
Balanced investment portfolios are essential for mitigating risk. Each separate investment you make reacts differently to changes in market conditions. Some investments will go up, and others will go down. A diversified, balanced portfolio with smart investments should ideally perform well, even if some of your individual investments don’t. By spreading your investments across various asset classes, you’re protecting your investment.
Because professional, experienced portfolio managers design the models, they should be pre-balanced. For instance, a low-risk, long-term investment portfolio might have a typical 60/40 asset allocation mix—60% stocks and 40% bonds.
What are the benefits of a model investment portfolio?
Though it might be considered an investment “trend,” model portfolios have several benefits. However, I’d recommend assessing your specific investment goals before making any decisions. This can help you determine whether the benefits outweigh the potential disadvantages of investing in a model portfolio. As always, investment advice from a financial advisor can help you determine whether a model portfolio fits your needs.
Some benefits of model investment portfolios include:
Investing typically takes more than just money—it requires significant time investments, too. Finding the right balance of assets to meet your goals and preferred risk level takes performing market research, tracking stocks, seeking out expert market insights, and assessing your intuition.
Because model portfolios are premade, they don’t require any research. The investments have already been decided—all you have to do is pick the model that fits your needs!
Here’s the thing about finance management: it comes at a cost. The more management your portfolio requires, the more your management fees go up. Though model portfolios might need a little tweaking, they’re intended to be the simple option. Less portfolio management can lower your overall management fee. This can make models more appealing to those on a fixed income or who otherwise have little disposable cash.
Of course, this is ultimately up to whoever manages your portfolio. So, best practice is to discuss their payment structure before making any decisions.
Many retirement options, such as some 401(k)s and target date funds, don’t target the investor’s specific needs and goals. If your finance manager offers a portfolio model, they’ve probably put together several types of models for you to pick from. Each model is probably targeted at its own set of goals. This lets you select a portfolio more aligned with your money personality, risk tolerance level, and financial goals.
Built by a professional
Experts typically build model portfolios. They have the experience to create a portfolio for a specific purpose or goal. Most likely, they’re licensed financial advisors. This means they’ve taken the advice people usually pay for and used that knowledge when building the portfolio. In essence, you’re receiving expert advice and its resulting portfolio all in one transaction.
Disadvantages of a model portfolio
Of course, investment options this simple can come with disadvantages. That doesn’t mean they’re not useful—they just require a little consideration before deciding.
To help, here are some common disadvantages of model portfolios:
One size fits all
Though your advisor might have many options available, each is intended to appeal to large swaths of customers. This makes them a little too one-size-fits-all for some investors. While you might find options close to your goals, they might not be exactly what you need. And although your advisor can tinker with your chosen portfolio to fix this issue, it could cost you the time and money you were trying to save by choosing a model.
Model portfolios are geared toward specific goals, but there’s no guarantee they’ll meet them. If you frequently check in with your portfolio, you might be able to catch this. If not, you could reach the end of your investment horizon with much less growth than you’d hoped.
While investments are always a risk, a more hands-on option can receive consistent attention and upkeep from your portfolio manager. While you can ask your manager to rebalance or tweak your portfolio, this could incur additional management fees you were trying to avoid.
This might not be a concern for those choosing a model portfolio because you don’t believe you have the experience or knowledge to invest.
However, for those who prefer to be in the weeds and making investment moves, models might not be your best option. Odds are, choosing a model portfolio requires ceding some (or all) control over your investments to the portfolio’s manager. While a good manager will work closely with you to ensure you’re getting everything you want from your investment, any changes are ultimately their decision.
Investing is a complex, nuanced endeavor. Not only does the market itself fluctuate and frequently change—so, too, do the goals and feelings of investors.
Though your original goals might be safe, long-term investments (such as when planning for retirement), that could change. As you learn more about the market, you might decide you’re ready for more short-term, high-risk investments. Or you could decide that you’ve taken on too much risk and would prefer to play it a little safer.
But most model portfolios aren’t built with this in mind.
In fact, model portfolios can sometimes be a simplified example of a successful investment option—designed to be successful at the time of creation. It might not take into account daily changes or long-term fluctuations.