Creating an investment portfolio is one of the first steps towards growing your money. However, it is not easy to filter out all of the noise and get real advice.
For most of us, investing money isn’t a full time job. We don’t have the time, energy, or expertise to be changing our investments multiple times a week like the professionals do.
This is the reason why we need to have a diversified investment portfolio that doesn’t require constant attention, but will allow our money to grow at a reasonable rate – which we would suggest is 4% per year.
The point of portfolio diversification is to be invested in different asset classes so that when some asset classes drop, other classes rise – and your overall investment dollars are protected.
We will first go over what you should consider when building a portfolio, and then share our portfolio with the actual assets that we bought.
What to consider when building an investment portfolio?
Many investors follow a 50% stocks and 50% bonds model as a benchmark for their allocation.
This popular approach operates on the following assumptions:
- Bonds are always are safer than stocks.
- Bonds and stocks always move in opposite directions such that if stock values drop then bond values rise – and vice versa.
We would suggest that those two assumptions are not true.
The two primary reasons that overall market prices move in significant ways are:
- Unexpected inflation/deflation in the economy.
- Unexpected economic growth/decline in the economy.
Here is a chart that shows what types of investments do well in each scenario.
From the chart, we can see that sometimes stocks and bonds move in the same direction – which is not good for diversification.
When you diversify your investment portfolio, the point is to diversify your risk.
Different asset classes, such as stocks and bonds, have different levels of risk. Since stocks are riskier than bonds, then you must have more bonds than stocks if you want the risk to be balanced.
If we agree with this train of thought, then we can see why the traditional method of allocation (i.e. by percentages of assets as measured by dollars, rather than risk) is not the best way to diversify your investment portfolio.
When you match the direction each asset class moves in each type of market situation with their relative risk, then you get a real “all weather” portfolio.
According to Ray Dalio, a good portfolio for average person should look something like the chart below.
P.S. For those who aren’t familiar with Ray, he is the founder of the world’s biggest hedge fund (Bridgewater Associates), and manages over $160 billion dollars (yes billions with a capital B!). His fund is so successful that he often turns new investors away. Also, if you have less than $100 million to invest then forget about having Ray manage your money. The big takeaway here is that Ray is someone who knows that he’s talking about.
When we look at this sample investment portfolio over the last 75 years, only ten years were losing years. Your worst yearly loss is only 3.93%, and you would have easily earned an average of 4% per year – which we feel is a realistic and conservative goal.
In contrast, the overall stock market was negative 18 times, and the largest annual loss over the same 75 years was a whopping 43.3% . Ouch!
How to implement your investment portfolio?
Now that you have a good idea of how much of each asset class you should own, it’s time to start buying the assets! There are an enormous number of ways you can reach your target allocation for each asset class. No matter how you get there, you should keep the following in mind:
1. Stay away from buying individual stocks. As mentioned in a previous article, you should buy the whole market through an index fund or ETF.
2. Stay away from funds or ETF’s that have fees over 1.0%. Since we’re only buying funds or ETF’s that track the index, there is no reason to pay high fees to investment advisors.
3. You should purchase the investments in a tax sheltered account such as a Roth IRA whenever possible.
Keeping those things in mind, here is one of the ways you can implement the suggested portfolio.
30% Vanguard S&P 500 ETF (Symbol: VOO). This one accounts for your entire “stock” allocation. This ETF tracks the S&P 500 index in the United States, and is a good gauge for the overall market. We love this ETF as the fees are only 0.03% of your invested amount.
15% Vanguard Intermediate Bond ETF (Symbol: BIV). This one is for all of your “intermediate term bonds” allocation. This ETF tracks the 5–10 year government bond index, and has a fee of only 0.07% – which is very good for a bond ETF.
40% Vanguard Long Term Bond ETF (Symbol: BLV). This one is for all of your “long term bonds” allocation. This ETF tracks the long-term investment-grade U.S. bond market, and also has a fee of 0.07%.
7.5% iShares Gold Trust (Symbol: IAU). This one accounts for all of your “gold” allocation. This investment is for actual gold bullion. As of 2019, the trust holds almost 300 tonnes of physical gold. At 0.25%, the fee on this investment is slightly higher than the others. However, the higher cost makes sense as you’re holding physical gold which needs plenty of security!
7.5% Invesco DB Commodity Tracking (Symbol: DBC). This one accounts for all of your “commodities” allocation. This fund tracks the prices of over ten commodities including oil, wheat, zinc, natural gas, and soy beans. The fee for this fund is at 0.85% which is still below our maximum recommended fee threshold of 1%.