Portfolio Report Card: A $512,000 One-Trick Pony

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Diversification means different things to different people. In some cultures, diversification means having large families to diversify so that when mom and dad get old, there will be plenty of children and grandchildren to care for them in their old age. For the individual investor, diversification boils down to spreading your risk across a variety of major asset classes. Can owning just one stock or mutual fund inside your portfolio get the job done?

My latest Portfolio Report Card is for Chris, a successful 47-year old entrepreneur who retired 12-years ago after selling his novelty shop.

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After years of having his money mismanaged by brokers, Chris fired them. He now manages his $512,000 investment portfolio all by himself and he owns just one mutual fund; the Franklin Income Fund class-A shares (Nasdaq:FKNIX).

Before I give Chris his final Portfolio Report Card, let's examine his investment account together.

On diversification, Chris' one-trick pony portfolio of FKINX misses asset exposure to major categories like commodities, REITs (NYSEARCA:RWO), and TIPS (NYSEARCA:GTIP). Thankfully, FKINX does have exposure to other key assets like U.S. (NYSEARCA:SCHB) and international stocks (NYSEARCA:EFA), bonds (NYSEARCA:CWB), and cash. Nevertheless, Chris' current investment strategy is weak on diversification.

What about the actual cost of Chris' portfolio?

Unfortunately, too many income investors are focused on the wrong ball and Chris is no different. In an email to me, he said, "I use FKINX's dividend as income which gives me around $2,240 per month." He's so fixated on his monthly payments, he sees nothing else.

On the surface, many observers would quickly point out that FKINX carries a 30-day SEC yield of 3.16% - which is higher than the S&P 500's yield (NYSEARCA:VOO). But that's only part of the story. Look at how much of that income or dividend is being eaten by FKINX's expenses.

FKINX Chart

The fund's annual expense ratio is 0.62%. Put another way, FKINX consumes almost 20% of its yield, which is clearly way out the ballpark in what an investor should be sharing with fund managers. Also, FKINX has inhospitable load of 2.25% (breakpoints for Chris' $512k account) which is still a high entry fee for future money he decides to add.

All investors should take deliberate steps to minimize taxes. That means smart asset location and tax-loss harvesting when warranted. It also means not investing in mutual funds that needlessly increase your tax liabilities when better choices are available elsewhere. Here too, Chris can improve.

FKINX has a tax cost ratio of 2.21%, meaning shareholders over the past year have paid around 2% of their assets to taxes. From an asset location angle, Chris can do a better job by strategically using a combination of tax-deferred and taxable brokerage accounts to cut his tax liabilities.

What about performance?

From 7/17/13 to 7/17/14, FKINX gained 14.66% vs. a 12.18% gain of blended benchmark of index ETFs with the same general mix of 33% US stocks, 13% non-US stocks, 34% bonds, 13% convertible bonds, and 7% in cash.

Chris' final Portfolio Report Card is a "C."

While FKINX is classified as a "conservative income fund" Chris' biggest risk is a lack of diversification. This is true from an asset allocation and asset location perspective. He's got his nest egg concentrated in one nest.

Also, if Chris does a better job of minimizing his investment costs, it should substantially increase his portfolio's income.

Ultimately, his current portfolio strategy relies completely on the very difficult long-term challenge of Franklin's fund managers to outperform the market. It's the kind of bet and act of faith that Chris might win, but the odds are stacked against him.

Ron DeLegge's Portfolio Report Card challenge stands: If your investment portfolio scores an "A", you'll get paid $100. Ron grades family trust accounts, 401(k) rollovers, 457 plans, 403(b), UGMA accounts, and anything posing as an "investment."

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

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