A common reason for abandoning a broadly diversified portfolio is impatience with performance. It's not easy seeing the S&P 500 race higher while your own diversified portfolio plods along.
Of course, hardly anybody appreciates the reverse -- those times when the S&P 500 lags, but a diversified portfolio holds its own (or even advances). With that in mind, let's take a look at what a broadly diversified portfolio might look like.
Let's assume you're a fairly conservative investor and your portfolio consists of 50% stocks and 50% bonds. I know that's boring -- but contrary to popular belief, investing isn't supposed to be exciting or entertaining. If you're looking for excitement, go skydiving.
Besides, many traders are more conservative than they think. If you tend to move into cash at the first whiff of a market downturn, that indicates a low risk tolerance. I'm aware that some trading methodologies teach this, but these systems generally chase single-stock performance and completely ignore inconvenient realities like tax consequences.
Anyway, let's say your 50% stocks/50% bonds portfolio looks like this:
● 24% -- Global fixed-income. Investment-grade global bonds with maturities of five years or less.
● 23% -- One-year fixed-income. Investment-grade domestic bonds with maturities of one year or less. There's nothing high yield here. (If stocks are supposed to be boring, that's even more true of bonds.)
● 12% -- Domestic core equity. Broad-market domestic stocks. Essentially, the Russell 3000.
● 11% -- International large-cap value equity. Large-cap foreign value stocks.
● 9% -- U.S. large-cap value equity. Large-cap domestic stocks that are beaten down for one reason or another. You want these because they typically outperform growth stocks (to many investors' surprise).
● 6% -- Small-cap U.S. stocks. Generally speaking, these are stocks with $300 million to $2 billion in market cap.
● 5% -- Emerging-market small-company stocks. You need these because they can add growth to your portfolio, and because they have a low correlation to other asset classes. That said, most U.S. investors would have a hard time picking these stocks on their own. When was the last time you heard of a trading system including small emerging-market stocks in its database?
● 4% -- Emerging-market value stocks. These are larger emerging-market stocks from the "beaten-down" category.
● 3% -- Real estate. Real estate investment trusts (REITs) are another asset that often shows low correlation to other equities. That's why you want to own them.
● 3% -- Cash. This means a money-market fund, not Benjamins stashed under the mattress. You want a money-market fund in the same portfolio as your stocks and bonds so you can take advantage of "buy-low" opportunities when they arise.
I'm not specifically recommending the above portfolio to you, because I know nothing about your personal situation. A more-aggressive allocation would be more appropriate for some investors, while or more-conservative one would make sense for others. The example above is to just to split the difference and see what a 50% stocks/50% bonds portfolio might look like.
Either way, I suspect the allocation above looks pretty different from what most U.S. investors hold. I see plenty of portfolios, and they generally have little or no international exposure. They also often have a bond side that's a mash-up of unnecessary municipals, high-yield debt and some Treasuries.
But don't be the person with a portfolio like that!
Why? Well, in a future column, we'll look at how the asset mix above has performed recently.
And we'll talk about the awkward situation of sticking with your chosen asset allocation rather than abandoning it just because it's become uncomfortable to hold.
