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Scott Burns Advice
OK. You're tired of the original Couch Potato portfolio. (It is possible to have too much of a good thing, even sloth.)
And now you've expanded to the Margarita portfolio. Do you dare build a portfolio more complicated than mixing a three-part drink?
You can do it easily if you use the building block approach. Rather than using a complicated recipe for different investments, all in different amounts, you can build a portfolio out of equal-sized blocks. And it can have 4, 5, or 6 pieces.
How about more? Like up to 10?
Well, it's more than possible. One of the nice things about the number 10 is that it makes for easy division. Just subtract a decimal place from your total portfolio and that's what you need to invest in each of your building blocks.
Here's the recipe, by pieces, for up to 10 building blocks:
Block 1: Domestic total stock market, such as Vanguard Total Market Index fund/ETF
Block 2: Treasury Inflation Protected Securities, such as iShares TIPS
Block 3: International total market, such as Fidelity Spartan International Market
Block 4: International bonds, such as American Century International Bond
Block 5: REITs, such as the Vanguard REIT ETF
Block 6: Energy, such as the Vanguard Energy ETF
Block 7: Large U.S. value stocks, such as iShares Russell 1000 Value ETF
Block 8: Small U.S. value stocks, such as iShares Russell 2000 Value ETF
Block 9: Emerging markets, such as Vanguard Emerging Markets ETF
Block 10: International value stocks, such as iShares International Value ETF
The building block portfolios start with a conservative 50 percent equity commitment that earned 7.92 percent in 2006. Then, block by block, you can add broad diversification until you have a portfolio that is about 80 percent geographically diversified equities.
More important, the last three blocks will add a value and size tilt to your portfolio. This will allow you to capture the added return that research by Eugene Fama and Kenneth French has shown to explain virtually all additional returns over a broad market index.
The last building block, International Value, has become available as an ETF index fund only in the last year, so I can't provide returns for the three-year and five-year periods. But if you examine the table below, you'll find that the returns rise smoothly as the equity commitment increases from 50 percent to 80 percent.
Will this much diversification save you from a down market?
Sorry, no. It is likely, however, to provide milder ups and downs than less-diversified portfolios.
This table shows the returns of equal investment funds, mostly index funds, designed to build asset class diversification. |
Source: Morningstar Principia, data for unscheduled portfolios 12/31/2006
Will it be expensive?
Not a chance. The combined expense ratio of the 10 investments is only 33 basis points--- one third of one percent. A $50,000 portfolio of 10 investments, rebalanced annually, would have a maximum commission cost of $120 a year, assuming a $12 commission rate. That would add another 0.24 percent. It would bring total costs to 0.57 percent. If you have a larger portfolio, use a smaller number of blocks or use a few index mutual funds instead of ETFs, your costs could be much lower.
This article is re-printed with permission from Scott Burns, Chief Investment Strategist at Asset Builder, Inc. Mr. Burns ranks as one of the five most widely read personal finance writers in the country. Visit Mr. Burns' site, www.scottburns.com for more investment and finance information. |
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