Filed under: ETFs, Investing Basics, Investing
The securities industry has a vested interest in making investing as complicated as possible. If you’re dazed and confused, you are more likely to trade too frequently and purchase complicated, high-commission investments. Good for your broker. Bad for you.
The secret the securities industry doesn’t want you to know is that responsible, intelligent investing is disarmingly simple. It requires relatively little time or effort. Almost anyone can put together a risk-adjusted portfolio that will have higher expected returns than those suggested by the typical broker. I am going to give you one such portfolio. Your broker will hate it.
The Smart, Easy Portfolio
The portfolio I describe in this example consists of only two holdings, both of which are low-cost exchange-traded funds.
For the stock portion of the portfolio: iShares MSCI ACWI (ACWI). For the bond portion of the portfolio: Vanguard Total Bond Market ETF (BND).
Initially, investors have to determine the allocation of the portfolio between stocks and bonds. This is a critical decision because it will determine the amount of risk the portfolio contains. The higher the allocation to stocks, the greater the risk assumed. Lessen the amount of risk by allocating a higher percentage of the portfolio to bonds.
There are many helpful asset allocation questionnaires online.
Should You Consider This Portfolio?
If you have significant assets that meet the minimum of a reputable registered investment adviser, you would be well advised not to make investing a do-it-yourself project.
This portfolio, however, may make sense in some situations for long-term investors who have the discipline to stay the course during periods of market volatility. If your time horizon is less than five years, you should have little or no exposure to stock market risk.
How Risky Is the Stock Portion of This Portfolio?
IShares MSCI ACWI tracks the performance, before fees and expenses, of the MSCI World Index. This index captures large- and mid-cap stocks across 23 developed markets, and it’s designed to measure the performance of the global stock markets. Think of it as giving you broad exposure to stocks in the major developed countries.
You can expect the volatility of this portfolio to be slightly higher than the volatility of a portfolio holding an S&P 500 (^GPSC) index fund. Even though you could describe this risk as “moderate,” in periods of extreme volatility, it can lose a significant portion of its value. For example, in 2008 the index lost 40.33 percent.
How Risky Is the Bond Portion of This Portfolio?
In my view, the purpose of the bond portion of your portfolio is to mitigate risk during periods of stock market volatility. I do not believe bonds should be used to increase returns. If you want higher expected returns, you should increase your allocation to stocks. Vanguard’s Total Bond Market ETF is a conservative fund designed to track the performance of the Barclays U.S. Aggregate Float Adjusted Index. This index consists of a broad spectrum of public, investment-grade, taxable, fixed income bonds in the United States.
Because of these holdings, this bond fund is very conservative with low volatility.
Long-Term Performance
The inception date for ACWI was March 2008, so it’s more instructive to look at the long-term returns of the MSCI World Index. Since May 31, 1994, the index had an annualized return of 7.41 percent. Its 10-year return ending 2014 was 6.61 percent.
Remember these returns assume that 100 percent of your portfolio was allocated to stocks. This would be far too risky for most investors. Depending upon the portion allocated to bonds, your overall portfolio returns would have been lower.
Compared to the returns of the typical investor, these returns are impressive. By some estimates, for the 20-year period from Dec. 31, 1993 to Dec. 31, 2013, the average investor had returns of a puny 2.5 percent.
The Importance of Discipline
Despite what your broker and the financial media want you to believe, deciding how to invest is relatively simple. The hard part is staying the course during periods of market volatility. As respected author William Bernstein noted: “‘Stay the course’: it sounds so easy when uttered at high tide. Unfortunately, when the water recedes, it is not.”
Keeping you on track so that you don’t panic when the market drops is one of the primary reasons most investors benefit from using competent registered investment advisors.
Ease of Maintenance
Once investors set their asset allocation and purchases these two ETFs, there’s very little left to do.
All investors should rebalance periodically. This ensures your risk profile remains intact. When appropriate, you should engage in tax-loss harvesting. If you have a life event that changes your tolerance for risk (like a divorce or an inheritance), you will have to adjust your asset allocation.
Your primary challenge will be to do nothing. Ignore the financial news. Pay no attention to predictions or the musings of pundits. Make no effort to time the market. Ignore short-term market volatility. Keep this sage advice from columnist Mitch Tuchman at the forefront of your thinking: “By far, the most effective long-term investments are the most boring — low-volatility stocks and indexes, sleepy collections of bonds and portfolios that don’t change for months.”
Daniel Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is “The Smartest Sales Book You’ll Ever Read.”
Permalink | Email this | Linking Blogs | Comments
Source: Investing
