In part 2 of this article, we will examine the performance results of a 2 style portfolio blend by excluding the third style Small Cap Value portfolio (as presented in part 1) from the allocation mix; this in consideration of those investors who may have concern about having portfolio exposure to the greater volatility as represented by the small cap universe.
Diversification Using 2 Portfolios
In charts 8, 9, and 10 of part 1 of the article, we can see that the volatility, as measured by peak to trough drawdowns, was highest with the Small Cap value portfolio. By excluding the Small Cap Value portfolio from the allocation mix (and consequently forgoing style diversification), performance was improved. These results are seen in charts 11, 12, 13, and 14 below:
Chart 12 dollar growth of each separate portfolio allocation and the combined total return of the 40-60% blend since 1994:
Chart 13 represents the second example of diversification "blend" using just the Quality Dividend Growth and Growth portfolios.
Similar to the 3 portfolio style blend, Quality Dividend Growth was again assigned a 60% allocation and the Growth portion was assigned 40%. After each 5 year period, the allocation percentages were switched so that the Quality Dividend portion received 40% allocation and the Growth portion each increased to 60% allocation, accompanied with a rebalance:
Such that the value that the annual rebalancing added to the 10 stock Quality Dividend Growth portfolio over the non rebalanced version (in charts 2 and 3 in part 1), so did the 5 year 60/40% allocation "switch" between Quality DG and Growth styles provide value versus the "non switched" versions.
The charts shown below present an overview of the $ returns and compound growth rates of select items that have been covered in part 1 and 2 of the article. We can see that the rate of growth for Quality Dividend portfolio slowed dramatically from 1994-2013 versus the 1970-1989 period and that the performance of the combined diversified style blends took the lead in the latter. As the data used for the Growth portfolio calculation in the 1970-1989 period was taken from the Nasdaq OTC composite and that the Nasdaq 100 outperformed the Nasdaq OTC Composite from 1985-1989 (and beyond), we conject that the performance for the blends would have been improved if the Nasdaq 100 was a viable option for use in the portfolio in that period.
An additional item included for comparison in chart 15 is a mix of Vanguard funds that is part of their "Target Retirement" series (as with many other investment companies' "Target date" offerings) and is a popular choice with the disciples of the John Bogle investment approach. The portfolio construction is a diversified, equal weighted mix of three Vanguard funds:
- The Total Stock Market ETF (NYSEARCA:VTI)
- The Total International ETF (NASDAQ:VXUS)
- The Total Bond Market ETF (NYSEARCA:BND)
In the calculation, the mix was rebalanced every 5 years in order to maintain consistency with the calculation of the other portfolio blends in this article.
As we can see, the compound returns and dollar accrual of the Quality Dividend Growth and the Vanguard Target portfolios were admirable. The returns for many conventional retirement plans constructed using Exchange Traded Funds seem to fall somewhere in between that of the Quality Dividend Growth and Vanguard "Target retirement" trajectories shown in chart 15. Yet, we can see that as the Vanguard series and these conventional plans would be adequate for a workers who are in their 20's and 30's and in their accumulation phase, they would be hardly adequate for a "slow" starter investor in their 50's or 60's. Of course, the sources for income and contribution amounts applied towards a plan during accumulation years are dependent on many disparate factors and asset accrual targets will vary.
Surprisingly, focusing on volatility concerns, the largest peak/trough drawdown for the Vanguard portfolio in chart 18 fared slightly better than the buy & hold of the Vanguard Small Cap Value ETF (NYSEARCA:VBR). Granted, as the sample size used in the volatility calculation for the Vanguard portfolio is smaller than the other portfolios in the study, the results seem to run counter to the premise that holding a broadly diversified portfolio of funds (including the incorporation of a total bond fund) provides "less risk".
In the broad world of retirement investment plan choices, there are many different schools of thought and somewhat confusing misconceptions. As shown in this study with additional input from the previous articles:
1) Tactical asset allocation models that have produced repeatable and consistent outcomes when applied to a small cap value and growth stock universe, and combined with a buy & hold of a quality dividend growth stock portfolio, have produced steeper asset accumulation trajectories over various 20 year investment periods versus an exclusive buy & hold portfolio of dividend growth stocks; further providing style diversification, albeit with more volatility.
2) Tactical asset allocation models (in "1") when applied to a growth stock universe and combined with a buy & hold of a Dividend growth stock portfolio, have produced steeper asset accumulation trajectories over various 20 year investment periods versus an exclusive buy & hold portfolio of dividend growth stocks, providing less style diversification yet with only slightly more volatility.
3) It is conceivable that investors who have had a "late/slow" start in their tax deferred retirement asset accumulation, could utilize items #1 & 2 and accelerate asset accumulation while participating in style diversification albeit with somewhat additional risk.
4) The use of the term "less risk" in literature regarding a broadly diversified portfolio of Vanguard funds targeted towards retirement is a misconception (see here).
Last but not least are questions pondered such as:
Can the particular stock choices selected for the study (in the Dividend growth portfolio) continue producing the same returns that have been sustained over the last 40 years? Will expanding products and services into Chinese and Indian markets be the key ?
These stock choices were younger companies 40 years ago. In comparing charts 15 & 16, if the growth trajectory of these choices has in fact slowed, what companies would represent the "new" era dividend growers as replacements for the maturing companies in order to achieve the types of returns produced in chart 16?
Would a dividend ETF used in place of the portfolio of individual dividend growth stocks be a reasonable option?
We frequently drive our research with the reminder that "there's gotta be a better way".
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.