Sunday, April 25, 2010

Some Real Portfolios

I thought it might be helpful to discuss some real portfolios that I've been involved in developing. I'll start with the simplest portfolios, and then move to the more complex. The idea is to expose you to a variety of asset allocations, each having been designed based on the willingness, ability and need of the investor to take risk, along with ability and willingness to handle portfolio complexity.

Since the most important asset allocation decision is the allocation between stocks and fixed-income (fixed-income is cash and bonds), the stock/fixed-income allocation is presented first for each portfolio; this is referred to as the top level allocation. Then, the stock and fixed-income allocations are further subdivided into lower level asset classes. By stocks I actually mean mutual funds that invest in stocks, and by bonds I mean mutual funds that invest in bonds. By cash I mean savings accounts, CDs, money market accounts, and similar cash-like assets.

In this post, I'll simply present the portfolios. In subsequent posts, I'll discuss the stories behind the portfolios; i.e., the design, construction, maintenance and performance of the portfolios.

Portfolio 1: Simple, aggressive, global equity portfolio

Investor: 20-25 year old individual
Investment horizon: 40-70 years
  • Top level allocation
    • 100% Stocks
    • 0% Fixed-Income
  • Stock Allocation (100% of portfolio)
    • 50% Vanguard Total Stock Market Index (US stocks)
    • 50% Vanguard Total International Stock Index (non-US stocks)
Note that this portfolio is 100% in stocks (aggressive), and 50% in non-US stocks (global).

Portfolio 2: Simple, moderately conservative portfolio

Investor: younger retired couple
Investment horizon: 20-30 years
  • Top level allocation
    • 40% Stocks
    • 60% Fixed-Income
  • Stock Allocation (40% of portfolio)
    • 65% US (Vanguard Total Stock Market ETF)
    • 35% International (Vanguard FTSE All-World ex-US ETF)
  • Fixed Income Allocation (60% of portfolio)
    • 80% Bonds (Vanguard Short-Term Investment-Grade Bond, Vanguard Intermediate-Term Investment-Grade Bond)
    • 20% Cash (Vanguard Prime Money Market and savings/checking accounts)
Note that the stock portion of the portfolio above consists of ETFs (Exchange Traded Funds) rather than index mutual funds.  They function basically the same in the portfolio.  I'll discuss why we used ETFs when we delve into the story for this portfolio.

Portfolio 3: Moderately complex, conservative portfolio

Investor: older retired couple
Investment horizon: 10-15 years
  • Top level allocation
    • 20% Stocks
    • 80% Fixed-Income
  • Stock Allocation (20% of portfolio)
    • 60% US
      • 80% Vanguard Total Stock Market Index (US stocks)
      • 20% Vanguard REIT Index (US Real Estate Investment Trust stocks)
    • 40% International
      • 75% Vanguard Developed Markets Index
      • 25% Emerging Markets Index
  • Fixed Income Allocation (80% of portfolio)
    • 40% Bonds (Vanguard Short-Term Investment-Grade Bond, Vanguard Intermediate-Term Investment-Grade Bond, Vanguard Inflation-Protected Securities fund, and a few others)
    • 60% Cash (Rewards checking account, high yield online savings account, money market accounts)

Note that as we get into more complex asset allocations, as above, I break down each sub-asset class so that the components equal 100%. I prefer to think about a sub-asset class as a percentage of its "parent" asset class, rather than as a percentage of the total portfolio. For example, t
his is why I list Total Stock Market Index as 80% of US stocks, but keep in mind that it makes up 48% of all stocks (80% of 60% = 48%), and only 9.6% of the entire portfolio (48% of 20% = 9.6%).

Portfolio 4: Moderately complex, aggressive, global portfolio

Investor: high school age individual
Investment horizon: 50-80 years

  • Top level allocation
    • 80% stocks
    • 20% fixed-income
  • Stock Allocation (50% of portfolio)
    •  50% US
      • 50% Total Stock Market Index or Large Cap Stock Index (large blend)
      • 25% Value Index (large value)
      • 25% Small Cap Index (small blend)
    • 50% International
      • 75% Developed Markets
      • 25% Emerging Markets
  • Fixed-income allocation (20% of portfolio)
    • 80% bonds (Vanguard Intermediate-Term Investment-Grade Bond)
    • 20% cash (money market and rewards checking account)
When I get into the story behind this portfolio, I'll talk about why I've listed Total Stock or Large Cap for the large blend holding. It has to do with tax loss harvesting, which is beyond the scope of this article.

Also, I want to note that the international portion could be in only the Vanguard Total International Stock fund, since this fund currently has about 75% developed markets and 25% emerging markets. However, the actual portfolio also holds the Developed Markets Index and Emerging Markets Index. One reason is tax loss harvesting, but another reason is that it enables rebalancing the portfolio to the target 75%/25% mix of developed and emerging markets if the percentage of emerging markets in the Total International fund diverges significantly from our 25% target.

Portfolio 5: Complex, aggressive portfolio

Investor: 25 year old individual
Investment horizon: 40-70 years:
  • Top level allocation
    • 80% stocks
    • 20% fixed income
  • Stock allocation (80% of portfolio)
    • 60% US
      • 55% large blend
      • 15% large value
      • 15% small blend
      • 15% small value
    • 40% International
      • 60% developed markets
      • 25% emerging markets
      • 15% international small blend
  • Fixed-income allocation (20% of portfolio)
    • 100% cash (rewards checking account)
I haven't listed specific funds for the above portfolio, because quite a few funds are used in several different accounts (e.g., traditional IRA, roth IRAs, 401(k)), and more than one fund sometimes is used within the same asset class. The reasons for this complexity will be discussed when we delve into the story for this portfolio.


  1. Under stock allocation, I forget what the difference is between "blend" and "value." For example, small blend and small value. What are these? I would love any expansion on portfolio 5...

  2. Nice to see some comments!

    Value is a term for stocks of companies that aren't growing quickly, or for some other reason, are not highly valued. Growth is a term for companies that are growing quickly, and are highly valued. Blend is in the middle. For more on this, see Asset Allocation Part 2 from January 2010.

    I plan to go into details on all of the portfolios, but will work through them in order, so it may be awhile before I get to portfolio 5.

  3. Thank you for all this great information. It is exactly the information I need.

  4. So, Kevin myself and my wife are 72 and 67. Our spending is covered by SS, pension and returns (if any) on our portfolio. We don't need to touch the principal. I am thinking that we could go with Portfolio 4 or 5 in our situation, even though these are targeted to younger investors. Agree?

    1. Sure, as long as you really have the willingness to take that much risk; i.e., would be OK seeing the value of your portfolio drop 40% or more, not knowing how long it would take to recover.

      Your situation is not that atypical. You have high ability to take risk, but low need to take risk, so you could go with anywhere from 0% to 100% stocks, and probably be OK. You can use your willingness to take risk to dial it in.

      Another way to look at it is that you're investing your portfolio more for your heirs than for yourselves. From this perspective, your investment horizon could be much longer than your expected lifetimes, for example if your children are your heirs.

      I am in a similar situation, but I learned a lot about my willingness to take risk in 2008/2009, so I go with only a 30% target allocation to stocks. I would consider increasing that if we had another severe bear market, and I found that my willingness to take risk was then higher than it was in 2008/2009.

      Here's a post I did on ability, willingness and need to take risk, a framework I learned about from Larry Swedroe:

      Based on my experience with my family and friends since I published this post, I now lean toward simpler portfolios for most people--something like a 3-fund portfolio, using a total US stock fund, a total international stock fund, and a bond fund.

      I personally currently prefer using a combination of CDs and Treasuries for the fixed-income portion, but this is more complicated, and perhaps not appropriate for most people.