Simple Portfolio Building: Growth

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Includes: AOR, DTN, GLD, TIP, VEA
by: Brad Kenagy

This article will be the fourth in a series of articles about simple portfolio allocations for different levels of risk tolerance. In this article I will be constructing a growth portfolio of ETFs.

There are two goals I had for constructing the following portfolio:

  • Make sure the portfolio is diversified as measured by correlations.
  • Reduce the volatility of the portfolio by weighting the least volatile funds higher than more volatile funds. I used the 3 month average volatility over the last 12 months. Volatility data is from ETFreplay.com.

Portfolio Funds

Growth

Symbol

Weight

Volatility

iShares Barclays TIPS Bond

(TIP)

30%

4.90%

WisdomTree Dividend ex-Financials

(DTN)

35%

8.20%

Vanguard MSCI EAFE ETF

(VEA)

25%

16.70%

SPDR Gold Shares

(GLD)

10%

19.00%

Fund Selection Method

I selected the above funds by roughly following the overall allocation of stocks and bonds, in the corresponding allocation ETF, the iShares S&P Growth Allocation (AOR) ETF.

The fund allocated roughly 60% to equities, and 40% to Bonds. For the portfolio I chose to go slightly more aggressive than AOR, by making the portfolio 60% Stocks, and 30% Bonds, and adding in a 10% allocation to gold.

For the fixed income allocation of the portfolio I decided once I crossed the 50/50 allocation point, I would move to a single bond fund for the portfolio. Following the same method of fixed income fund selection for the previous portfolios I have done, I included the most volatile bond fund from the balanced portfolio, which was TIP. The second reason I included TIP is that TIP should benefit when interest rates rise because of inflation.

To find the best equity fund, I used to following guidelines using the TD Ameritrade ETF screener:

  • Morningstar Category: Large Blend, Large Growth, Large Value.
  • Total net assets: Greater than $1 Billion.
  • Dividend Yield greater than 2%.
  • 3 yr Market Return is greater than 0.
  • ETF Type is Equities.
  • Chose the fund with the lowest Standard Deviation.

Based on the above criteria, there were 9 ETFs that met this criteria Large Cap U.S. equities, so in the previous Balanced portfolio I had used VIG because it had the lowest standard deviation, so I decided to use the fund that was right in the middle on the nine funds ranked by standard deviation, which turned out to be DTN, so I included it as the Large Cap U.S. equity fund for the portfolio.

Based on the above criteria, there were 5 ETFs that met this criteria for international equities, so in the previous Balanced portfolio I had used EFG because it had the lowest standard deviation, so I decided to use the fund that was right in the middle on the five funds ranked by standard deviation, which turned out to be VEA, so I included it as the international equity fund in the portfolio.

The growth portfolio is the first portfolio that I included a third asset class besides stocks and bonds. I debated between using a futures-based broad commodity fund or a physically backed commodities fund, and decided that a physically backed commodity fund would be better. So using the same criteria as above for the equity fund selection, excluding the dividend criteria, and changing the ETF type to commodities, I found that there were 7 funds that met those criteria, and out of those 7 there were 3 physically backed funds, and the one with the lowest standard deviation was the GLD, so I included in the portfolio.

Below is a table showing the correlation of each fund to each other as well as each fund the iShares Barclays Aggregate Bond (AGG) and the SPDR S&P 500 (SPY).

Correlations

Data from ETFscreen.com.

AGG

DTN

GLD

SPY

TIP

VEA

AGG

1

DTN

-0.56

1

GLD

-0.07

0.40

1

SPY

-0.58

0.97

0.40

1

TIP

0.68

-0.45

0.09

-0.43

1

VEA

-0.58

0.92

0.09

0.94

-0.42

1

Returns and Data

Data from ETFreplay.com.

The following charts and data show the portfolio compared to the iShares S&P Growth Allocation ETF.

Portfolio Challenges

Like all the previous portfolios I have done in this series, bond interest rates have been the big challenge, but as each portfolio moves further out on the risk spectrum, the volatility is more tolerated by someone who is willing to accept that greater volatility. With the portfolio a step further out on the risk spectrum, there is more added equity risk because of the larger allocation to U.S. equities, as well as a larger allocation to international equities.

Closing Thoughts

The returns of the portfolio over the time period have outperformed AOR by a wide margin over the last 3.5 years. But the portfolio accomplished the outperformance with about 25% less volatility than AOR, but I did have that expectation because of the 10% allocation to GLD instead of using that 10% for a bond fund like AOR does.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer