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A few months ago, I made a major career change. I left behind my lucrative advertising career to begin something much more enriching. I am now a Streetwise Coach at ING Direct Canada. I provide financial advice and guidance with respect to four very simple (but effective) index-based portfolios. Three of those portfolios include four holdings. The all-equity fund has only three holdings. It is quite an eye-opener to discover how one can create extensive diversification and manage risk (volatility) with only four indices.

I will outline the portfolio composition and later in this article I will quickly detail how U.S. investors can create their own Streetwise Portfolio.

The Streetwise Portfolios select from these four indices.

1. A broad based bond index

2. A Canadian equity index

3. A U.S. equity index

4. An International equity index

From there, they simply use asset allocation to create four portfolios to match clients' time horizon, goals and risk tolerance.

The Streetwise Balanced Income Portfolio

  • Canadian bonds 70%
  • Canadian equities 10%
  • U.S. equities 10%
  • International equities 10%

The Streetwise Balanced Portfolio

  • Canadian bonds 40%
  • Canadian equities 20%
  • U.S. equities 20%
  • International equities 20%

The Streetwise Balanced Growth Portfolio

  • Canadian bonds 25%
  • Canadian equities 25%
  • U.S. equities 25%
  • International equities 25%

The Streetwise Equity Growth Portfolio

  • Canadian equities 50%
  • U.S. equities 25%
  • International equities 25%

The Streetwise Portfolios were launched just before the market meltdown of 2008-2009. That said they have recovered nicely (they have some very solid three and five year numbers) and the asset allocation models are on track to deliver the gains one would expect over the long term.

Here are the Streetwise Portfolios - American style. Now I do have to take one liberty here. Canada is some 4% of the world economy. The U.S. is 25% of the world economy. It certainly makes sense for Canadians to invest in the U.S. market in considerable amounts. For U.S. investors, Canada offers some very useful diversification and currency exposure as I outlined in these articles here and here, but certainly Canada does not warrant equal amounts to U.S. and international markets for U.S investors. Given that, I took the liberty to reduce the Canadian exposure.

The Streetwise Balance Income Portfolio (U.S.)

  • U.S. bonds 70%
  • Canadian equities 5%
  • U.S. equities 12.5%
  • International equities 12.5%

The Streetwise Balanced Portfolio (U.S.)

  • U.S. bonds 40%
  • Canadian equities 10%
  • U.S. equities 25%
  • International equities 25%

The Streetwise Balanced Growth Portfolio (U.S.)

  • U.S. bonds 25%
  • Canadian equities 15%
  • U.S. equities 30%
  • International equities 30%

The Streetwise Equity Growth Portfolio (U.S.)

  • U.S. equities 50%
  • Canadian equities 15%
  • International equities 35%

And here are the low cost indexes that one can purchase to create the Streetwise Portfolio models. EFA is an ETF that tracks EAFE with holdings in Europe, Australasia and the Far East. EFA invests in developed nations.

  • U.S. bonds - (NYSEARCA:AGG) or (NYSEARCA:BND)
  • U.S. equities - (NYSEARCA:VOO) or (NYSEARCA:DIA)
  • Canadian equities - (NYSEARCA:EWC)
  • International equities - (NYSEARCA:EFA) or (VIDMX)

Here's how the Balanced Growth Portfolio (U.S. model) would have performed over the last 10 years. The Balanced Growth portfolio with 75% equities and 25% bonds would have delivered a total return of 98%, outperforming the S&P 500 total return of 83%.

Thanks to low-risk-investing.com for the portfolio calculation tool. Please note that AGG was limited to September of 2003, I used that as a starting point for the portfolio backtest. Here's how those returns were distributed.

Interestingly, creating a portfolio that adds two equity indices that each inherently possess more volatility than the U.S. index can (in combination) create a portfolio with much less volatility than the Dow 30 or S&P 500. And that of course is due to the fact that the Canadian and International indexes can offer low correlation to the U.S. market, and are at times somewhat inversely correlated. What equity market do you think offered the best returns last year, selecting from Canada, the U.S. and EAFE? U.S. - nope. Canada - nope. It was EAFE that holds Europe and Japanese equities that many investors do not want to touch. EAFE delivered to the tune of 18.8% in 2012. And look at the ten year returns for the indices in our backtest - that's EAFE in second place. EAFE's the bridesmaid, but that's pretty decent considering the recent events.

Outperforming the total U.S. stock market with much less volatility, what's not to like? Adding in bonds and international diversification can certainly pay off. With a starting point in 2003 the holder of the Streetwise Balanced Growth Portfolio (U.S.) would never have had to watch their portfolio head under water. In 2009 that asset mix would still be 20% above water, while the U.S. equity markets were nearly 20% under water. And the Balanced Growth Portfolio delivered 7.4% average annual returns over 10 years. That's quite attractive given the times. The all-stock Equity Growth model would have delivered average annual returns of over 9% over that 10-year period, with a near 1% annual boost above the U.S. market's returns.

It's sports analogy time.

Why not have four strong players on your portfolio team, instead of one? As we've seen, one or more of your players can get injured. That's when you need another player to come in and pick up the slack. And it's always a good idea to have that solid player on your bench who is concerned with nothing but defense. His name is Bond, AGG Bond.

Stick with those players, don't trade them away just because they're having a bad season - and you'll win in the end. You'll at least finish near the top in your division.

Source: Streetwise Portfolios: Beating The U.S. Markets With Lower Volatility