Saturday, April 23, 2016

The Ideal ETF Portfolio


Here is what I would consider an ideal portfolio:

12.5% SPY - Large Cap
12.5% EFA - International Value
12.5% EEM - International Growth
6.25% IWM - Small Cap
6.25% QQQ - Technology

25% USD - US Dollars
6.25% AGG - US Bonds
6.25% EMB - International High Yield
6.25% BNDX - International Bonds
6.25% HYG - High Yield

This is only what I would consider a theoretical target for a retirement aged investor under normal circumstances but as everybody knows the market frequently operates under conditions that may be described as anything but normal.  I also suffer from the same mistakes that many investors suffer from such as reacting on emotion or bad analysis.  As time passes however, I intend to learn from my mistakes and aim to rebalance my own real portfolio in this direction but only ever plan to reach perfect balance as often as a tight rope walker does at the circus.  

Why not just rebalance immediately after getting out of balance?

I think that it is important to give investments room to breathe which means not always changing them in the way you would rip off a bandage.  Whether an investment is working out well or going badly it is important to recognize that the timing of profits are anything but predictable and the more time that you give to an investment the greater chance that it has to grow properly.  Instead of being quick to cut investments that are not working consider investing in smaller portions over longer periods of time to help reduce bad timing risks.

Why such a large allocation to cash?

Cash is like the king on a chessboard...it has very little functionality on its own but the game cannot be played without it.  In my own experiences I have noticed that the market frequently punishes certain companies and even whole sectors for various reasons only to eventually forget about those reasons over time leading to a recovery.  Keeping cash is like an insurance policy that allows you to take advantage of these special situations when they arise providing a nice risk adjusted return that I think rivals the safest of investments, even treasuries.  Many investors consider an investment falling in price an indicator of increased risk...I tend to think the opposite especially if there is no material change in the fundamental characteristics of the investment itself.

Why such a small allocation to the S&P?

I don't know why so many investors consider the S&P the only game in town.  I've heard plenty of arguments such as the perpetual strength of the US or the multinational orientation of many of its companies but based on what I've learned over the past decade about investing...there is no such thing as tenure or incumbency advantage when it comes to markets.  In the absence of sound information, which is probably 90% of the time, I must weight assets and opportunities equally.  Maintaining a diversified portfolio is just as much about staying power as it is about holding different types of assets.  You need to be able to survive your mistakes in order to learn from them.  This type of thought process has brought me success in the past and I believe will continue to bring me success in the future.  

Is there an ideal portfolio for everybody?

Everything changes and everyone's circumstances are different which could lead to drastic differences in what one would call the ideal portfolio.  Do you have large mortgage or student loan debt or do you work at a place that pays low but has lots of potential?  Diversification doesn't have to stop with your portfolio but can be applied to your whole life as well.  Think about how you can use your unique circumstances to shape and even strengthen your ideal portfolio and you’ll be on your way to discovering who you really are as an investor.  Remember as always, don't over do it, stay diversified and think long term.

Read Next: The BIG Picture