We all want higher returns and less volatility from our investments Asset Management Wealth Advisory. There are hundreds of websites and newsletters promoting a new fund or stock or strategy – but how can we know whether it really works and how can I use it in my existing portfolio?
There is an easy to understand path to higher returns with low risk: Simply stated:
If you have a portfolio with funds from different market segments (asset classes). For example: US and international stocks, real estate, bonds. Then, over the long term, you will get better results at a lower risk than picking the latest and greatest fund or stock. This is proven and widely used – being the basis of most money managers strategies
The simplest strategy is to “buy and hold” the assets and only re-balance the asset ratios (Strategic Asset Allocation) periodically. For example, if you start with 60% bonds, 20% US stocks and 20% international stocks, after six months it is likely that the ratios are no longer 60/20/20 and you need to re-balance the funds to bring it back into the correct ratio
Over the past decade “buy and modify” (Tactical Asset Allocation) evolved whereby you keep the same market segments but you may change the ratios depending on market conditions. For example, while the stock market is very volatile, the ratio of bonds increases to provide more stability
To demonstrate this, we created the simplest portfolios imaginable and called them SIBs (Simpler Is Better). We take the market indices for each of the market segments represented in the portfolio. This means that no effort is spent in trying to pick the best stock; we take the whole market segment. This is much easier and less stressful than constantly looking for what’s hot and making sure you don’t have a dud in your portfolio.
We built SIBs for three, four, five and six asset classes and measure historical returns for a buy-and-hold strategy and a buy-and-modify strategy. The table shows the makeup of each SIB in terms of the asset class represented in each portfolio.
Three SIB: Bonds, US stock, International stock
Four SIB: Bonds, US stock, International stock, Real Estate
Five SIB: Bonds, US stock, International stock, Real Estate, Emerging Markets stock
SIX SIB: Bonds, US stock, International stock, Real Estate, Emerging Markets stock, Commodities
The stock index funds we used for each of the SIBs came from Vanguard:
Bonds: Vanguard Total Bond Market Index (VBMFX)
US Stock: Vanguard Total Stock Market Index (VTSMX)
International Stock: Vanguard Total International Stock Index (VGTSX)
Real Estate: Vanguard REIT Index (VSSIX)
Emerging Markets Stock: Vanguard Emerging Markets Stock Index (VEIEX)
Commodities PowerShares DB Commodity Index Tracking Fund (DBC)
Intermediate-Term Bond Vanguard Total Bond Market Index
To measure results, a moderate portfolio was selected: i.e. a blend of 40% bonds with 60% evenly spread across the other asset classes. The results were measured over five years – it’s possible to get returns over a shorter period but they may not be realistic of the long term potential.