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The smart way to fine-tune your portfolio 2017

Reprinted courtesy of

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Today I’ve got a new twist on a topic I have written about and updated every year of this century.

The purpose is to help you determine how much of your portfolio should be in equities and how much in bonds. The new twist is that I’m offering four variations for making up the equity part of the portfolio instead of only one.

This presentation is based on market data for 47 calendar years, 1970 through 2016.

If you think of this article as a “decision tree” of important choices, you’ll be able to follow step by step and wind up with a diversified portfolio that should work well for you.

Some journal and magazine articles contain an “executive summary” of their major points, presumably for readers with little time or patience for details.

In that spirit, here’s a two-part executive summary of this article (I’m pretty sure you know both these points already): 

  • First, risk and reward continue to move together. If you want higher expected rewards, you should expect to take more risk.
  • Second, you have lots of interesting choices that are likely to continue to produce favorable long-term results.

Your risks and returns would have varied depending on how you chose the asset classes for the equity side of your portfolio – and that’s the theme of this article.

Beyond those general statements, the payoff comes from digging into some details. So roll up your sleeves, and let’s dig.

The “decision tree” I will walk you through has three questions. Two of them involve your choice of equities. The third involves the mix of fixed-income funds vs. equity funds.

  • First, will your equity portfolio include growth stocks in the form of blend funds, or will it invest only in value funds?
  • Second, will your equities be evenly split between U.S. and international funds, or will you keep 70% of your equities in the U. S.?
  • Third, how much will you hold in equity funds and how much in fixed-income funds?

Equities: Growth vs. all-value

Since the 1990s, I have recommended an equity asset allocation that includes blend funds (made up of growth stocks and value stocks, hence the name) as well as value funds. This has the effect of overweighting the portfolio to value while still retaining some growth stocks. (The most familiar example of a blend fund is the S&P 500 index, made up of the largest U.S. companies.) I have called this combination the Ultimate Equity portfolio.

Recently, however, I have begun suggesting that investors consider what I call an all-value portfolio, one that eliminates most growth stocks. Thus, instead of owning a large-cap blend fund that tracks the S&P 500 SPX, +0.18%  coupled with a U.S. large-cap value fund, an all-value investor would own only the latter fund.

The all-value approach (which I call the Ultimate Value portfolio) would also eliminate the U.S. small-cap blend fund, the international large-cap blend fund and the international small-cap blend fund.

I described this approach in detail in an earlier article.

Here’s a comparison of returns and a few risk factors from 1970 through 2016.

Table 1 – 100% equity

Portfolio Compound return Standard deviation Worst 12 months Worst drawdown
Ultimate Equity 11.4% 14.7% -51.2% -58.6%
Ultimate Value 12.1% 15.1% -52.7% -60.1%

One obvious conclusion from those numbers: Ultimate Value achieved a significantly higher return than Ultimate Equity, without much additional risk.

Equities: 50% U.S. vs. 70% U.S.

My longstanding recommendations have called for half the portfolio in U.S. funds and half in international funds. I still think that’s the right allocation, as more than half the world’s investment assets lie outside the United States.

However, many people over the years have balked at having so much of their money invested outside this country. They are simply more comfortable owning funds that hold U.S. stocks (even though the investors have never heard of most of those companies) and less comfortable owning foreign funds.

(In investment circles, this is called “home bias.” I was recently in New Zealand and learned that investors there prefer to keep the majority of their equity investments in New Zealand companies.)

Therefore, I’ve computed 1970-2016 returns and risk factors for versions of Ultimate Equity with 70% U.S. assets and only 30% international.

Table 2 – 100% equity

Portfolio Compound return Standard deviation Worst 12 months Worst drawdown
50% U.S. Ultimate Equity 11.4% 14.7% -51.2% -58.6%
70% U.S. Ultimate Equity 11.4% 14.6% -50.6% -58.5%

As you can see, the differences were minimal over this 47-year period.

The comparison is similar for these two versions of the Ultimate Value portfolio, in which a 70% U.S. mix bumped the compound return up from 12.1% to 12.5% and the standard deviation up from 15.1% to 15.7%.

My conclusion is that U.S.-centric investors aren’t likely to suffer dire consequences if they keep 70% of their equity investments in U.S. funds.

Risk: Equities vs. fixed income

Fortunately, this step of the decision tree isn’t an either/or matter. You can (and most likely should) have both equities and fixed-income funds in your portfolio.

The question of exactly how much of each is larger than we can adequately address here. However, I can point you to some excellent resources (which I’ll do soon) and give you some comparative results based on a portfolio with 60% equities and 40% fixed income.

Table 3 – 60% equity, 40% fixed income

Portfolio Compound return Standard deviation Worst 12 months Worst drawdown
Ultimate Equity 50% U.S. 9.6% 9.1% -33.6% -38.1%
Ultimate Equity 70% U.S. 9.5% 9% -33.1% -37.7%
Ultimate Value 50% U.S. 10% 9.3% -34.8% -39.1%
Ultimate Value 70% U.S. 10.2% 9.6% -34.3% -39%

Again, the conclusions are similar: Ultimate Value added return without adding significant risk; and it didn’t make a big difference whether you kept 50% or 70% in U.S. equity funds.

I should add, by the way, that the fixed-income part of these portfolios was identical in each case: intermediate-term U.S. Treasury Bonds.

Although 60% in equities is a good allocation for many investors, it’s not optimal for everyone.

On my website you’ll find a series of tables that give year-by-year results from 1970 through 2016 for these portfolios in 10% increments of fixed income and equity exposure. So, for instance, you can see how you would have fared with a portfolio invested in 30% equity or 90% equity.

For help with how to get the most out of those tables, I suggest you consult an article I wrote last year.

For more on this important topic, check out my podcast, 2017 Update of fine-tuning Your Asset Allocation.

Richard Buck contributed to this article.