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Best Fidelity Funds to Diversify Your Portfolio

We get a lot of questions about the best funds to build a well diversified portfolio. There are many factors that go into it, but here is an article we published that describes one way to identify some good candidates. This article builds around the Fidelty funds, but the same approach can be used to select ETFs to get many of the same benefits.

Almost any article in the popular press about building an investment portfolio is quick to advise that you need to build a diversified portfolio. You then get some rule of thumb about buying stocks and bonds, or you need to buy 8 stocks from different industries, or you need 5% in precious metals or international stocks.

Here we will analyze the best mutual funds for diversifying your portfolio, and we will put try to quantify the impact, so you can see for yourself the improvement to not just the total return but the reduction in portfolio risk that you can get by properly diversifying.

The key to making diversification work is to find alternatives to the investments that you already have that not only have superior returns, but are not correlated to your current holdings, that is their day to day changes in value do not track another of your existing holdings.

For this example, we will use the Fidelity mutual funds family, simply because there are over 100 Fidelity equity funds alone, including the Fidelity Select Funds. This gives us a large universe of diverse options that should allow us to find the best Fidelity funds for our portfolio, with the convenience of keeping it all in one account.

We will start with a basic diversified portfolio of 70% Fidelity FSMKX, which tracks the S&P 500. Add to that a 30% holding of bonds, Fidelity Bond Index (FBIDX). This portfolio, if rebalanced quarterly from 1995 to 2005 inclusive, would have returned 11% annualized. The maximum drawdown (that is the most its value dropped from a previous peak) would have been a fairly steep 30% or almost 3 times the annual return. That of course was after the over 2 year bear market from March 2000 to October 2002 (when the S&P 500 had a 50% drawdown, which was better than the Nasdaq 100 almost 80%).

We then calculated the correlation of the Fidelity Equity Funds to that portfolio, while screening out some of the more volatile Select Family. The best Fidelity funds that showed a very low correlation to our portfolio were the Fidelity Real Estate fund and Fidelity Health Care fund. Both of these Fidelity funds have a long history (over 15 years) of providing reasonable good returns with reasonable drawdowns.

We reconstructed our diversified portfolio by adding 15% of each of these funds, so we now have and redistributing the rest, so the allocation now is:

50% S&P 500 index (FSMKX)
20% Fidelity bond index (FBIDX)
15% Fidelity Real Estate (FRESX)
15% Fidelity Select Health Care (FSPHX)

The portfolio was again rebalanced quarterly, for the same 11 years 1995 to 2005 inclusive. There resulting return was 12.5% per year, 1.5% better than the beginning portfolio. In addition, the drawdown was reduced to 24%, compared to 30% before. The drawdown is now only 2 times the annual return, a significant improvement.

As you can see, the real power of diversification is brought into play when we understand that low correlation between our investment holdings is key to making diversification work. Choosing a mutual fund family like Fidelity Investments that has a broad choice of sector mutual funds is a key part of choosing the best mutual funds for our investment portfolio.

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Comments on Best Fidelity Funds to Diversify Your Portfolio »

January 22, 2010

John Galloway @ 10:09 pm

I have been using the Fidelity Select trading system since July of 2009……For the most part it is working good by your picks….A couple of times I decided to use your two picks plus one that I chose, which twice has been a mistake.

There is one piece of advice that is not on this site, that of early sales. My understanding was if I held a fund less than 30 days, I would pay a .75% redemption fee, well you pay that plus Fidelity calls on the phone raising HELL about round trip trading….I recently sold FSESX because the bottom was falling out, to cut losses.

I think you should tell investors about ROUND TRIP TRADING
AND ABOUT THE RESTRICTIONS PLACED ON THEIR ACCOUNTS..

I do not know about you but I have minimum losses on an account of 5% to 7%….now I see the FSESX is down -8.2%

I told the guy from Fidelity to go to hell and fuck off. I told him my understanding of the fund rules and he say oh no!!! He said to read the fine print. He was right!!!!

He said I should trade ETFs, I told him to mind his own business….I told him I would probably move my account away from Fidelty because they were awful…They want you to ride the market down with all the oher idoits….lose 40% …people sit there and lose 50%…and Fidelty does not care, none of them care…they want you to buy and lose more!!!

March 16, 2010

jimmy mathis @ 8:40 am

interested in rolling over I R A . Just read the article on “Best Fidelity Funds to Diversify Your Portfolio”, 50% to FSMKX, 20% to FBIDX, 15% to FRESX, 15% to FSPHX. Do you still recommend this portfolio? I am 73 years old and my wife is 68, we have approximately $50,000 in each I.R.A. If so advice how to open our accounts.

May 5, 2010

John Galloway @ 9:23 pm

this is a very good site, but they are shutting it down. There is another site called Fundranker.com They give a lot of information free, but for $49/ first year and then $99/ year they are good. I have compared their picks to Fundztrader and they are in the same boat…Fundranker list 8 select funds in their portfolio…Also there is FidelityMonitor.com and there is reboundtrading.com

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