What Makes a Core Fund?

To start answering this question, let's talk about some of the qualities you may want to look for in a core fund and what types of funds may have those qualities.

The stock market is dominated by large companies (those that fall into the U.S. Large Cap market segment); such firms account for roughly three-fourths of the value of the U.S. market. Assuming that you want your portfolios to participate in the movements of the broad U.S. market, as opposed to just a small sub-section of it, you may want to use a large-company-focused fund as your core stock holding.

Large-cap blend funds, which own big companies, can be core stalwarts. Large-blend funds usually don't lead performance lists, but they're even less likely to bring up the rear. They can be less volatile and tend to be more stable, which can make them solid core choices.

For cautious investors, a conservative large-value fund may be a better option. These funds invest in big, well-established companies with stocks that are cheap relative to those of other large caps; they may also focus on dividend-paying firms. Historically, that focus on slow-growing, generally steady companies has earned large-value funds the lowest risk scores of any of the Morningstar style categories.

But wait. If large-cap funds are good core holdings, why not large-growth funds? These funds typically focus on large companies with the potential to grow more rapidly than the broad market.

Although there are exceptions, large-growth funds don't generally have the best temperament for core holdings; they tend to have bigger mood swings than their blend or value counterparts. Their highs are nice--they mean higher returns at certain points in time--but when they're down in the dumps, the losses may be bigger than you want at the heart of your portfolio.

If you choose to invest in large-growth funds, one way to potentially lessen the volatility in your portfolio can be to invest an equal amount of money in a large-value fund. This strategy would approximately mirror investing in a large-blend fund.

If you're concerned about staking everything on the U.S. market, you might want to include a foreign-equity fund as a core holding, too. This type of core fund usually focuses on the world's developed markets, investing in larger companies, just as the portfolio's core U.S. funds do.

Finally, a bond fund might make a good core holding if your personalized asset allocation calls for it. You may want to stick with bond funds that invest in high-quality securities and favor the intermediate part of the yield curve. Why? Because the longer a fund's maturity, the more volatile its returns generally are. Investors may be able to capture much of the return of a long-maturity fund with an intermediate-maturity fund, but with less volatility.

The Downside of Using Funds as Core Holdings

Now that we've talked about several different types of funds that may make good core holdings for a portfolio, it's important to also consider the downside of funds. You'll need to consider the expenses and management strategy associated with each fund. Fund managers often charge different expenses and fees to cover their management costs.

Two articles that may help you when considering different fees and expenses are Fees, which discusses different charges associated with mutual funds, and Compare ETFs to Other Products, which has an entire section devoted to different ETF expenses. It's also important to remember that the allocation strategy of a fund is handled by a manager, and some managers can choose to change their strategy without warning.

Read Next: What About Core Stocks?

Investors should consider the investment objectives, charges, expense, and unique risk profile of an Exchange Traded Fund (ETF) or mutual fund carefully before investing. A prospectus contains this and other information and should be read carefully before investing. A mutual fund prospectus is available through www.scottrade.com or through a Scottrade branch office. An ETF prospectus must be obtained from the issuer.