Trying to come up with a globally diversified, tax-efficient portfolio can be challenging in the best of times. With a bull market that is running longer than any other and hitting new highs almost daily, it is even more of a challenge. So, how should you prepare an investment portfolio that gets you to your goals and avoids getting wiped out? These are things I will be exploring in my new periodic series: Confessions of a Portfolio Strategist. Let’s start by looking at portfolio benchmarks.
Vanguard Wellington: My Portfolio Bogey
I’m a big fan of Vanguard Investments. What’s not to like? A large stable of funds, low-costs, decent returns. There’s a lot to be said about a passive investing approach which has been the mantra of Vanguard’s founder, John Bogle.
But active funds have a place, too. And one of the best, low-cost options around has a long, distinguished history: Vanguard Wellington. With a track record that goes back to 1929 and an overall expense ratio of 0.25% per year that is way less than the average active mutual fund (1%+), this is a fine fund. Both Morningstar and Lipper give it a high ranking, too (average 5-star rank).
According to its prospectus, the fund seeks conservation of principal, reasonable income, and capital appreciation without undue risk by investing 60% to 70% of assets in common stocks and 30% to 40% in bonds. It also includes exposure to foreign markets (10% to 15% typically).
So, I use this as a benchmark or “bogey” for almost all of my portfolios that I create for clients. I think it’s more realistic to compare a client’s portfolio with an investment that has all the same elements that a client portfolio will have: stocks (US and international) and bonds (US and international). It’s more realistic than comparing just to the S&P 500 which is just large US-based companies without any cash or bond components.
You can find the details of the holdings, stock allocation, and sector allocation through this link to MarketWatch.com.
Here is a side-by-side comparison of Vanguard Wellington with a proxy for the S&P 500 Index (Vanguard’s S&P 500 Index ETF, VOO).
Vanguard Wellington is about 50% large-cap US stocks, 12% international stocks, 24% US bonds, and 6% non-US bonds. The S&P 500 Index ETF is 100% stocks divided between US large-cap (86%) and mid-cap (13%).
Most investment adviser representatives will typically compare a portfolio with the S&P 500. This just doesn’t make sense on so many levels. I get it. It’s easier and the media uses it so it’s more recognizable.
But you really ought to compare apples-to-apples. And comparing a globally diversified portfolio that contains US and international stocks, bonds, and cash to an all-US stock index is not going to be fair.
Over time, the S&P 500 has had sharp ups and downs. This is illustrated by the most classic of risk measures: standard deviation. During the most recent ten-year period, the S&P 500 has averaged a return of about 7.7% with a standard deviation of +/-15%. Over a shorter time period it’s had a higher return (5-year return of 15% with a risk factor of 10% for the S&P).
Vanguard Wellington, on the other hand, has averaged about 7% return with a standard deviation of +/-10% or one-third less than the index. Over a five-year period it’s had a return of 10% and risk factor of 6%
Applying the “Rule of 72” means that with the average ten-year returns of either investment you’ll likely double your nest egg in about ten years. If “mean reversion” didn’t exist and you never wavered, you’d probably double your money in under 5 years by just investing in the S&P 500.
Sure, you’ll probably have a higher rate of return if all you did was invest in the S&P 500 Index. But most folks won’t have the stomach for the higher volatility that comes with that kind of portfolio. And for an investment fiduciary, it would violate all sorts of maxims about being “prudent” with a client’s money.
MarketFlex Portfolio Design
When I’m designing a client’s portfolio I’ll not only use Vanguard Wellington as a “benchmark”, I’ll also use it as a core position. While the fund is technically closed for new investors, there are a select few custodians that still have access to at least one share class of this fund (VWELX) and I’m fortunate to have access to this custodian platform for my clients.
So, generally, I’ll design my MarketFlex portfolios with Vanguard Wellington as a core (or a proxy I’ve created from several low-cost Exchange Traded Funds) and then add satellite positions around this. I do this to not only add some potential upside but also to add more protection on the downside.
Through these satellite positions, I can add more bonds or more alternative income-oriented investments like individual dividend-paying stocks or real estate. And depending on what research I dig up from one of the many newsletter services I read, I may want to add more in one area or another so I’ll use other specific portfolios of ETFs that I’ve created.
Since most investors tend to be overly concentrated in large-cap stocks, I like to add diversification to the size of stocks. In this case I often add a small-cap low-cost US index ETF.
And because what goes up may very likely go down, I like to include ways to hedge against a downturn. There are all sorts of ways to do this that I’ll talk about in another installment but the point is having a core-satellite approach has for me in the past and may very well in the future provide some downside protection to a portfolio.
Personal Benchmarking
Ultimately, what should matter is not whether or not you (or your portfolio) “beats” the S&P 500 index. What should matter is whether or not you’re on track for your goals. While all financial advisers will show you reports that compare your portfolio to something like the S&P 500, you really need to see how you compare to your own personal benchmark.
If all you need to sustain a successful retirement is a 2% return because you either A.) have a large portfolio to draw from, B.) have low living expenses, C.) have other guaranteed or passive income sources, or D.) some combination of all three, then how your portfolio is doing compared to what a talking head on CNBC is saying is irrelevant.
This goes into planning, knowing your goals, and what path you’ll need to follow to get there. That’s a topic for another day.
If you’d like an objective second opinion about your finances, please reach out to Steve Stanganelli, CFP®, CRPC®, AEP® at Clear View Wealth Advisors, LLC. Email him at Steve@ClearViewWealthAdvisors.com.
