Are you driving the financial equivalent of a "hoopdie," all dented and threadbare from years of neglect? Then, just like rap artist Xzibit does on the popular MTV television show, we're gonna pimp your ride and turn that rusted hulk of a portfolio into a tricked-out, fly set of wheels.
What's in your wallet?
If your portfolio consists of a series of penny stocks, fly-by-night operations, hot tips heard over the water cooler, and maybe even a smattering of mutual funds that are rotting your performance with hidden fees and high expenses, then you need a major overhaul.
The first thing a car mechanic will often do is hook up your car to a diagnostic computer to see how your engine is running. It essentially compares your car to a benchmark. You need to do the same thing with your portfolio by checking to see how your investments are performing against the market.
For a portfolio of diversified stocks, compare your performance against a broad market index fund like Vanguard's Total Stock Market ETF (AMEX: VTI ) . If you've got a bunch of small caps, check out the iShares Russell 2000 ETF (NYSE: IWM ) . If you've got primarily large caps, the S&P 500-tracking SPDR Trust (AMEX: SPY ) may be more appropriate. Similarly, for mutual funds, compare your portfolio managers against the market they're trying to beat. If your investments are beating the benchmarks, then you're doing better than the majority of actively managed funds that usually lose to the index.
Now that you know what's up with your portfolio, let's get rid of the rust spots, bald tires, and hanging roof felt.
Penny stocks are a particularly virulent form of decay in a portfolio. Sounding like great opportunities to get in on the next corporate wunderkind, many Pink Sheet denizens are simply vehicles to separate you from your cash and enrich the promoters. Now there are some very good companies that trade on the Pinks, like luxury car maker BMW and Tate & Lyle, the maker of sugar substitute Splenda. What you want to watch out for are the shell corporations that seem to operate by press release without turning out any meaningful products or services.
How about that hot tip you received on the company that was going to make toilet paper a thing of the past? Or the blimp maker that would make WiFi obsolete? We've all been tempted at one time or another to invest in some stock on a whim without much due diligence. If you don't know why you own a stock, what a company does, or where it's going, it's time either to do your homework or to jettison it from your portfolio. You don't need the flotsam and jetsam of someone else's get-rich-quick scheme clogging your portfolio's fuel line.
And if you own mutual funds, make sure they're not eating away at performance through the fees they charge. A fund can tout extraordinary performance, but once you include all the front loads, back loads, redemption fees, and 12b-1 fees, those same results look mighty ordinary -- if not poor in comparison.
Adding the chrome, bells, and whistles
Okay, you've got your portfolio up on blocks. You've stripped the fly-by-nighters, sanded smooth the stock tips, and drained away the thick, viscous fluid of any mutual funds fees that are slowing you down. Now comes the fun part where you rebuild your financial ride into a purring machine that'll turn heads and be the envy of Wall Street.
Like 22-inch Asanti chrome rims, a broad market fund will provide the necessary foundation to carry you toward your financial goals in style. It gives you instant diversification across many industries and company sizes. Heck, as we noted before, a portfolio that consisted of nothing but this index fund would probably beat the majority of all fund managers.
But when you're pimpin', you're looking for more than just the Ford Festiva. You want better than average returns. You're looking for quality, style, and yes, even some flash!
For that, turn to proven winners. Over the past decade, for example, amusement park operator Cedar Fair (NYSE: FUN ) has returned, on average, 11% per year compared to just 4% for the market. An investment in roller coasters in 1987 would have generated 500% returns for you. Clorox (NYSE: CLX ) would have returned more than 950% over that same period. First-class companies like these turn in outstanding performance year in and year out.
For your flash -- the financial version of trunk-mounted 12-inch Fusion woofers -- turn to the small-cap universe. Not the penny stocks that were loading you down before, but the great companies of tomorrow that will power your ride to financial freedom. Hansen Natural (Nasdaq: HANS ) started off with a tiny $10 million market cap, but returned more than 25,000% over the past 10 years. Or $111 million biopharmaceutical Celgene (Nasdaq: CELG ) , which returned more than 6,000% over the last decade and is now valued at more than $22 billion.
These companies aren't the sort of transient stock operators you should fear, but rather great growth companies that you can embrace and bolt onto your portfolio. Like teardrop mirrors and custom leather seats, small-cap stocks will be the head-turners that provide a smooth road for your financial future.
Your pimped-out Foolmobile
In just a few easy steps, you've turned a fiscal jalopy into a sporty sedan. No more will you be hoping and praying that the penny stocks you put your faith (and cash) into won't crash into a telephone pole. With high-quality small cap growth stocks, your portfolio's got a throaty idle as it waits to roar. We cast off all the unfounded stock tips we've received and welded proven long-term winners in their place. Lastly, you've given yourself high-performance shock absorbers in the form of a broad market index fund that will cushion you from the vagaries of changing investment styles.
Not only are you set for the future, you're styling too.
Cedar Fair is a recommendation of Motley Fool Income Investor. BMW is a Motley Fool Stock Advisor selection. Regardless of your investment style, the Fool has a newsletter service geared to your needs. Test drive any of them for 30 days, free of charge.