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What Are Model Portfolios? Are They Right for You?

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Should you use a model portfolio?

Whether you’re a new or veteran investor, you probably want a lot of different things from an investment. But, deciding which investments will help you achieve your financial goals may be a bit of a challenge. So, rather than putting together a portfolio of investments from scratch, many financial advisors will assign you to a pre-built model portfolio. Here’s what to expect from a model portfolio and what to consider when selecting one.

Model Portfolios Explained

Investment comes with expectations. Investors may seek high returns, low risk, tax efficiency and perhaps even social status. A financial advisor can assemble a model portfolio for investors and illustrate how it will achieve their goals.

Model portfolios are a diversified group of assets designed to achieve an expected return with a corresponding risk. Ideally, each portfolio has a combination of managed investments based on extensive research. These portfolio blend asset classes, investment managers and investment strategies to achieve diversification.

Typically, financial advisors or investment managers offer a variety of portfolios to correspond with your financial goals and objectives. Model portfolios allow investors to use simple and effective investment methods that require minimal management effort.

Advantages of Investing in a Model Portfolio

Should you use a model portfolio?

There are several advantages to investing in a model portfolio. Here are a few benefits you should consider when determining if this is the right investment choice for your financial goals and objectives.

Diversification 

A model portfolio allows you to diversify your assets. Diversification is an investment strategy that helps investors reduce risk by distributing funds across multiple financial vehicles, asset categories and industries. To maximize returns while reducing risk exposure, financial advisors select investments that may react in different ways when the same event occurs.

For instance, let’s say you decide to invest in railroad stocks. Then railroad workers go on strike and stock prices plummet. This scenario would cause your portfolio to take a severe hit. However, if you also invested in airline stocks, you may see an increase in share prices as people fly instead of taking trains. But, it could also have a negative impact on this stock because both are in the transportation industry. So, in an ideal scenario, you want to invest in a wide variety of securities in different industries to avoid a big loss when an event, such as our imagined railroad strike, occurs.

Research and Professional Analysis 

Another advantage of investing in a model portfolio is that knowledgeable experts in the industry probably designed them. Most financial advisors and investment managers use their professional analysis and extensive research to create detailed investment strategies and philosophies before selecting the assets for each portfolio. This means that they have put in place a clear review process for assessing each investment in the portfolio and will evaluate its individual performance on an ongoing basis.

Rebalancing 

Most investment advisors monitor and review their model portfolio to ensure it is meeting their benchmarks and performing at an acceptable level. Part of this process involves rebalancing each portfolio. By rebalancing your portfolio you readjusts the percentage of the portfolio that’s invested in each asset. This process involves the period of buying and selling off assets in a portfolio. It helps maintain the designated asset allocation.

For instance, let’s say the model portfolio’s desired asset allocation was 40% stocks and 60% bonds. If the bonds perform well, it may increase the allocation percentage to 70%. They would then need to sell some bonds and buy additional stocks to get back to the targeted allocation. By rebalancing financial advisors can maintain the right level of risk exposure.

Disadvantages of Investing in a Model Portfolio

Should you use a model portfolio?

When you commit to a model portfolio, you lose control of your asset management. If you feel uncomfortable handing over complete control of your money to a financial advisor, a model portfolio may not be the way to go.

Additionally, like all other investments, performance is never guaranteed. Even though model portfolios are under professional management, that doesn’t mean that they will perform. Even the best money managers can lose money in a slumping market.

A model portfolio also includes additional fees. Because you’re working with a financial professional to manage your money, you will have to pay fees for their time, expertise and the investments they select. Often, because of the investment selection, it’s hard to determine the exact amount you’re paying. So, if you do decide to invest in a model portfolio, make sure you understand the cost as well as the financial advisor’s fee structure.

Bottom Line

Model portfolios can be great options for investors who don’t want to take the DIY approach to investing. But before you invest your hard-earned money into a model portfolio, it’s important to understand how the portfolio works. You will also want to compare fees. The more knowledgeable you are, the better investment decisions you will make.

Investment Tips
  • A financial advisor can walk you through a model portfolio. They also can help determine if it’s the right fit for your investing style. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • If you are still a little apprehensive about using a model portfolio, you can start with a little investment and see how it performs. You might want to consider starting with a robo-advisor. TIt’s an online tool that offers lower fees and lower account minimums than traditional advisors. Since model portfolios require minimal effort and thought on your behalf, they may be what you need to keep your peace of mind.
  • It’s hard to put together a portfolio of any kind if you don’t know how much you’re investing or how much risk you’re willing to take. SmartAsset’s investing guide can answer some of those questions and let you know how taxes and inflation will affect your investment.

Photo credit: iStock.com/Sitthiphong, iStock.com/Tempura, iStock.com/Yok46233042

The post What Are Model Portfolios? Are They Right for You? appeared first on SmartAsset Blog.

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