6 Asset Class Retirement Portfolio With 3 U.S. Equity ETFs Added: Strengthened Returns?

Includes: IJJ, RSP, VBK, VTI
by: MyPlanIQ

We are working through a series of articles to help improve returns for retirement investors. As the first baby boomers prepare for retirement with the financial meltdown still vivid in our minds and emotions we are attempting to build a set of funds that are easy to understand yet have the potential to deliver good returns at a low risk. We want to keep it simple and understandable. We believe that this type of investing can be understood and going one step at a time will hopefully make it clear and reduce some of the angst.

What we have seen is:

  • Increasing diversification from three areas to six can make a significant impact on simulated historical returns
  • Only a few retirement plans (~4%) have six asset classes but it may be possible to create a holistic portfolio with the combination of IRA and 401K plans
  • We have added a managed bond fund in this critical area at a time when fixed income is under pressure and that part of the portfolio would benefit from active management. Note that we have picked what is probably one of the gold standards of recent years and not all managers are created equal
  • The current set of funds we have developed are VTI, VEU, BND, VNQ, VWO, DBC, PTTDX
  • There are a number of alternatives for the funds such as EFA for VEU and USCI for DBC

In the last article we took something of a detour to compare a wide range of funds to show where the SIB benchmark sits and we saw that it sits in the middle of the range for six asset plans and in the top 5% overall. We may look at the plans that beat and why but we are getting back to building other funds in to see what impact they have.

All of the other asset classes are treated equally in the sense that the investments will be spread equally between the other asset classes so no one class is more important than the other. We will start with the US Equity classes mainly because there are a large number of choices to be had. Using a web based app to search through many choices can bring good results. In fact we have already written on this topic when we compared the Shell to Morningstar's retirement plans. Shell has over 300 funds whereas Morningstar has under 30. Both achieve similar returns. For a web app, 300 is no problem but for humans, 30 is probably about the limit. However, we note that more and more brokers such as Vanguard, Schwab, TD Ameritrade are offering commission free ETF plans with as many as 100 funds in the plan so perhaps this is the wave of the future.

For now, we are going to keep the number of funds as small as possible and give a rationale for each one we choose. MyPlanIQ maintains updated information on major ETFs in most asset classes -- we will determine which sub-class we want and then go to the rankings to make the selection.

To keep things simple, I am only going to select three funds for US Equities. Many plans have a dozen or more but that is not the point of the exercise. It is important to note that we are not experts in selecting individual funds. In fact, we invite experts to create their own plans on our system and invite them to share them with other users so they can benefit from expert opinion and we have seen several very good plans.

My three picks are:

  • One Large Cap Blend
  • One Mid Cap Value
  • One Small Cap Growth

My rationale for these choices are:

  • When the market is in poor shape, there will be a movement to safe stocks and that will likely be large cap blend
  • When the market starts to recover, there will be a move away from large to medium cap and a focus on value
  • When things are going well, small cap growth equities will be a good choice

I am sure there will be many opinions on whether this rationale works and it is possible to put in another selection. I am going to use the ETF rankings and pick the highest performers over the 5 year horizon and the selections I make are:

  • Rydex S&P Equal Weight (NYSEARCA:RSP)
  • iShares S&P MidCap 400 Value I (NYSEARCA:IJJ)
  • Vanguard Small Cap Growth ETF (NYSEARCA:VBK)

It is possible to make different selection and measure historical returns but these are the choices I make for this exercise and we will now review the historical returns against the previous version with just VTI. Note that I have removed VTI from the list of fund choices.

Performance chart (as of Mar 9, 2011)

click to enlarge

Plan Comparison

Performance table (as of Mar 9, 2011)

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETF Benchmark With PTTRX-3USETFs Tactical Asset Allocation Moderate 13% 96% 11% 84% 14% 98%
Six Core Asset ETF Benchmark With PTTRX-3USETFs Strategic Asset Allocation Moderate 16% 124% 7% 31% 8% 40%
Six Core Asset ETF Benchmark With PTTRX Tactical Asset Allocation Moderate 14% 104% 11% 86% 14% 100%
Six Core Asset ETF Benchmark With PTTRX Strategic Asset Allocation Moderate 17% 125% 6% 28% 8% 39%

We first have to note that the graphical representation is now a little misleading because some of the US ETFs are younger than the venerable VTI so in the early simulations (before 2004) the three US choices were either cash or the ETFs once they became available. Note that our strategy waits for a year's history before deploying the asset.


  • In the longer term there is no appreciable difference at least rounded up to the nearest whole percent
  • In the short term, the simpler plan actually outperformed the plan with more funds which seems counter intuitive
  • In the three year time frame the plan with the extra funds wins with strategic asset allocation but makes not difference with tactical asset allocation

We have already covered the limitiations of momentum strategies and how that pertains to rotating sub-classes. In essence, over the past year, there have been no consistent trends established and either rotating asset classes in the case of TAA or rotating funds in the case of SAA has been counter productive. When a consistent trend is established, we start to see the benefits of this approach. We would expect that a year from today, benefits will be seen with a move to small cap growth compared to VTI but we won't know that until we get there.

This was beneficial in the three year time frame for SAA however, for TAA, US Equities were switched out for fixed income or cash in a very defensive posture and so it made little difference.

It is possible to point to a bad choice of ETFs but with this choice, there is little difference made to the portfolio and we will move on to see whether a better choice of international ETF's will make a difference to the portfolio.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Disclosure: Author is long DBC.