Seeking Alpha
Value, long-term horizon, dividend investing, dividend growth investing
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Introduction
As I am waiting for the premium pricing in the S&P 500 to disappear, I am thinking about how to allocate the lazy portion of my portfolio. In my intro article (here) I suggested that I would allocate roughly 2/3 of my portfolio to a lazy strategy of S&P 500 ETF like SPY (60%), S&P Mid Cap ETF like IJK (25%), and a S&P Small Cap ETF like IJR (15%). This decision was based on the limited, low cost funds available within my 401k provider options today. I put the distribution numbers out there with absolutely no thought behind the allocation. I will suggest a methodology of using Beta to weight historic return to dictate the initial allocation of my lazy portfolio. I am not sold on this idea, but I see it as one potential method to weight the portfolio to provide a premium return for a premium volatility. I look forward to your comments.

Goal

Instead of making up a random allocation based on 'gut' feeling, I thought it would be more important to determine why I wanted to invest in funds outside of the S&P 500 for the allocation of my lazy portfolio. After all, if it was truly lazy, why not just dump it into the S&P 500 and forget about it? My goal is to achieve a return greater than the S&P 500 while increasing the diversity in the portfolio. Because I am in for the long run (20+ years), I am fine with additional volatility in the portfolio over that time.

In order to meet my goal of incremental return vs. the S&P 500 and incremental diversification, I would like to turn to the index funds I mentioned above. I also would like to add one additional fund - RSP. RSP is a fund that is equal weighted investment in each of the S&P 500 companies. Scott Low provides a good overview of RSP (Article Here).

The Numbers

Below is an overview of the 10-year return, 5-year return, and 5-year beta for each of the 4 funds mentioned. I have also included the comparison to SPY in terms of total return over the respective time periods. The last column is the percentage point premium vs. SPY. This is calculated by the 5 year Beta minus 1 multiplied by 100. It represents the number of percentage points greater than beta for each fund.

 

10 Year Return

10 Yr Return vs. SPY

5 Year Return

5 Yr Return vs. SPY

5 Year Beta

5 Year %P Premium

SPY

69%

--

89%

--

1

--

IJK

154%

123%

174%

96%

1.12

12

IJR

151%

119%

127%

43%

1.21

21

RSP

120%

74%

133%

49%

1.19

19

Source: Google Finance

Strategy

In order to maximize the return for the variability, I would recommend the following structure:

  1. Take the lower value of the 10 year vs. SPY and 5 Yr Return vs. SPY
  2. Divide by the funds 5 year %P Premium (Return Per %P Premium below)
  3. Sum the Return Per %P Premium and calculate the weight of each (Calc. Weight below)
  4. Calculate the distribution of remaining share of the portfolio allocated to the fund (Allocated Recommendation below)

Results

After performing the above calculations, the recommendation is as follows:

 

5 Yr vs. SPY

5 Year %P Premium

Return per %P Premium

Calc. Weight

Allocation

SPY

--

--

--

--

50%

IJK

96%

12

8%

63%

32%

IJR

43%

21

2%

16%

8%

RSP

49%

19

3%

21%

10%

The result of this methodology is that portfolio is weighted towards the fund that provides the greatest reward for my stomaching each funds volatility.

Source: Using Beta-Weighted Return To Define My Index/'Lazy' Portfolio