Many investors, for instance, have collected "bottom-drawer"shares over the years that don't seem to have much of a useful place in their portfolios. These shares may have been inherited, bought at random from time to time or gained when a membership organisation listed on the market.

One way to go about tidying up a messy collection of investments is to think about what properly-diversified portfolio you would have created if you had started from scratch.

Perhaps put yourself in the position of a person who has rolled over large amount of super into a new self-managed super fund (SMSF).

The money in this SMSF example is in cash and is ready for investment. (For the record, recent tax office statistics show that more than 25,000 SMSFs were set up in 2017-18.)

Vanguard's approach for constructing Australian diversified funds, a research paper* by our investment strategists, gives four key principles that Vanguard uses in constructing and maintaining its professionally-managed diversified portfolios.

These principles – concerning investment goals, portfolio balance, low costs and investor discipline – are as applicable to individual investors as professional investment managers.

Goals
Have clear, appropriate and attainable goals for your portfolio. Critically, these goals should not rely on unrealistic expectations for investment returns or excessive risks.

Most individual investors have a series of goals such as saving enough for retirement, saving for a home deposit and paying off debt before retirement. Once your goals are listed, you can prioritise their importance.

Ask yourself such questions as: How much should I save in total to achieve my goals? How much should I regularly save to eventually reach my goals? How many years do I intend to keep working and saving?

Balance
Set or balance your portfolio's asset allocation to different asset classes appropriately for reaching your goals while staying within your tolerance to risk. (Asset classes include local and international shares, fixed interest, property and cash.)

And then regularly rebalance your portfolio back to its long-term strategic asset allocation to recapture its intended risk-and-return characteristics. (The portfolio of a professionally-managed diversified fund is automatically rebalanced.)

Costs
Minimise costs to improve your chances of better long-term returns. And never overlook that each dollar paid in costs, including investment management fees, is potentially a dollar less in your returns.

Repeated research, including by Vanguard**, concludes that the size of an investment fund's fees is the most-reliable and most-quantifiable predictor of future performance. This applies whether you are investing in index funds, actively-managed funds or a combination of both.

Discipline
Take a disciplined, non-emotional approach to following your investment strategy designed to meet your goals. Don't be thrown off course by overreacting to short-term market movements, the emotions of the investment "herd"and changing investment environments.

And avoid the trap of being an undisciplined performance chaser who switches to whatever is the latest highest-performing fund. Research, including by Vanguard, suggests today's performance winners have a strong chance of becoming tomorrow's losers. And today's losers could become tomorrow's winners.

* Vanguard's approach for constructing Australian diversified funds, published 2017.
**The case for low-cost index-fund investing, Australian edition, Vanguard 2018.

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
15 April 2019