When Your Portfolio Needs a Role Model - TheStreet

When Your Portfolio Needs a Role Model

Many investing Web sites offer model portfolios, and some come with an impressive record of returns.
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If you're fed up with the subpar returns most mutual funds provide, there is an alternative: model portfolios. And you'll find them all over the Web.

Model portfolios contain a collection of stock or mutual fund picks. But don't confuse these with the tips you find on the Web's myriad stock-picking sites. Usually the stocks or funds in a model portfolio are designed to balance one another out. You're told what stocks to buy and what percentage of your total portfolio should be allocated to each. Also, like mutual funds, model portfolios usually aim to achieve a particular investment objective, such as aggressive growth or income.

Some model portfolio sites are pretty bare-bones. At

Index Fund Investing

(

www.indexfund.com), for example, you'll find three model portfolios designed for conservative, moderate or aggressive investors. But there's little explanation other than that. You have to go to a site like

Morningstar

(

www.morningstar.com) to track the performance of the recommended funds, then decide for yourself if they make sense.

Model portfolios at

Wall Street City

(

www.wallstreetcity.com), a division of financial data provider

Telescan

, and

Zacks

(

www.zacks.com), the earnings estimate people, provide you with a little more hand-holding. Both sites create their model portfolios using computerized stock screens. And they publish detailed records on past performance.

Maybe the best model portfolios on the Web can be found at

Individual Investor

magazine (

www.iionline.com) and the

Motley Fool

(

www.fool.com).

By best, I don't necessarily mean the best performance, although in both cases it's respectable and then some. Rather, both these sites function as virtual online communities. The Motley Fool, for example, maintains seven widely followed portfolios that cover the gamut from aggressive investing to a dividend reinvestment program, or DRIP, portfolio for beginners. The investment style of each portfolio is clearly explained. Plus, the portfolio managers provide ongoing commentary on why they've bought, sold or held on to particular stocks. And they moderate discussions among visitors.

That's a whole lot more involvement than you get when you buy into a typical mutual fund. But model portfolios demand a certain amount of work on your part, too. At a minimum, after pouring over the managers' recommendations, you need to make the trades yourself.

Should you follow the advice without question?

Absolutely not!

First off, make sure the site isn't recommending these stocks as paid endorsements. This often occurs with small-cap sites. Read the disclosure carefully. But even if the model portfolio appears totally on the level, you should always spend a little time researching the company yourself. Then, only when the portfolio manager's decision makes sense to you, should you mimic his or her positions. And obviously don't put all your eggs in one basket. That is, don't allocate all the funds at your disposal to tracking a model portfolio. Divvy some up in other investments as well.

That said, if you do choose to follow a model portfolio blindly, the returns have proven to be pretty astounding. Zacks claims its model portfolio of No. 1 Ranked Stocks has been up 35% each year since 1980.

If you'd invested $50,000 back in 1994 and followed The Motley Fool's Rule Breaker portfolio, your money would have grown to $800,000 today (before taxes), a 1,500% return. As of Feb. 8, the MicroCap model portfolio at

America-iNvest

(

www.america-invest.com) claimed to be up just over 83% in the year to date.

Compare those returns to mutual funds. Only 7% of equity mutual funds have managed to beat the

S&P 500 index

over the last five-year period. So how is it that these free-advice Web sites can outperform highly paid money managers -- and do it so spectacularly?

Here are a couple of theories. For starters, all of us are apt to be braver when we're not trading with real money. And most model portfolios are just that: models. (The Motley Fool model portfolios are an exception and use the company's real money, however.)

And what's even braver than a person investing with play money? Maybe a totally dispassionate computer. Which might explains the fabulous long-term record of the stock-screening program at Zacks. A computer doesn't sweat and sell in panic during short-term downturns. Until someone pulls the plug, it stays with the program.

But there are other more subtle reasons why model portfolios might beat out most mutual funds. Fund managers often get paid based on the amount of assets they manage. It's to their advantage to play it safe rather than risk a loss.

Finally, there could be a little bit of self-fulfilling prophesy at work, especially when widely followed portfolios like the Motley Fool's enter or exit positions. Indeed, the Motley Fool now has a policy of announcing its trades about a week in advance to minimize their market impact. For $25 annually, you can receive email alerts of pending trades.

A logical next step might be a simple icon that would authorize your broker to make the same trade. When you think about it, there are a lot of other cool applications you can build into a model portfolio. How about more personalization, for starters? Trades could be matched with your own predetermined risk tolerance. Or how about simply more specialization? So far, the number of model portfolios is miniscule compared with the thousands of mutual funds that exist worldwide.

There's evidence that model portfolios have already influenced the way mutual funds are managed. Innovative new mutual funds

StockJungle.com's

(

www.stockjungle.com)

Community Intelligence

fund and

OpenFund

(

www.openfund.com) are attempting to create the same virtual communities that surround model portfolios at the Motley Fool and elsewhere. Both funds keep investors privy to their holdings and encourage their feedback. Too bad they have to use real money.

Mark Ingebretsen is editor-at-large with

Online Investor magazine and a consultant to a major insurance company. He has written for a wide variety of business and financial publications. Currently he holds no positions in the stocks of companies mentioned in this column. While Ingebretsen cannot provide investment advice or recommendations, he welcomes your feedback at

mingebretsen@onlineinvestor.com.