New Year's Resolutions for Fund Investors

Forget about those last five pounds and the work that needs to be done on the house -- it's time for some New Year's resolutions that you really need to make.

The new year is the perfect time to get your finances in order. Perhaps you've once again broken the bank on holiday gift-giving; perhaps you stayed within your budget. Clearly, you'll need to tackle any immediate cash-flow issues first. But once that's taken care of, turn to your portfolio and make sure it reflects your future, not your past. To that end, we offer a few resolutions that you can actually stick to. And if you put the work in now, you won't have to do anything beyond an annual checkup.

I will make my portfolio signal my current goals, not past mistakes. It's easy to be laggard regarding your portfolio's asset allocation, but few elements of money management will do more to ensure you meet your immediate and long-term goals. Make a list of all your accounts and note how they're allocated. Next make a list of your goals. Everyone should have at least three to six months' worth of expenses in a money market account -- more if your job is closely tied to the economy or if you anticipate a rocky time for other reasons. (Tenured college professors have less to worry about than computer consultants do, for instance.)

Once you've sliced off your emergency fund, take a look at the rest of your portfolio and see if it's in line with your goals. If you already own your home, don't anticipate sending kids to college in the next 20 years and won't retire for another 30, you can afford to keep a healthy portion of your portfolio in stocks. But any money that you expect to need in the near term -- no matter what you'll need the money for -- should be in less risky investments, such as bond or hybrid funds.

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This is also a good time to weed out any useless funds. The less money you have, the fewer funds you need -- but even huge portfolios rarely need more than eight funds. Start off with one broad market stock fund and one broad market bond fund. Then think about splitting your stock investments between growth and value; large- and small-capitalization stock funds. At that point, consider adding an international fund for added diversity. Your bond portfolio can be divided between Treasuries and corporate bonds. But don't feel like you need to go that far -- most investors can meet their goals with just a few funds. Fewer funds means lower expenses, less to keep track of, and less temptation to yank your money around. Which brings us to the next resolution...

I won't chase returns. Everybody knows that chasing returns is a loser's game. The problem is, most people don't realize that's exactly what they're doing when they hear that bonds are hot and flee their stock funds. "Fund flows are always a lagging indicator," says Morningstar analyst Scott Cooley. "By the time individual investors make a decision, the market's usually about to turn." Cooley points to 2000, when the stock market began its breakneck fall, and equity funds showed record inflows throughout the year. Not surprisingly, we had also been in a bear market for a couple of years before people started pulling their money out of stocks.

Money management shouldn't be reactive -- that's the main point. Plus, when you factor in trading costs, load fees, taxes and expenses, bouncing in and out of funds will almost certainly never pay off.