A Low Cost, Fully Diversified All ETF Portfolio

A friend of mine came to me for advice, asking for an all-ETF low maintenance portfolio well balanced between asset classes.

He is 35 has $30,000 to invest and plans to put aside around $500 a month in this portfolio for the next 5 years at least.

His goals were capital appreciation, outperforming the indexes, regular dividends and international exposure, including emerging markets, with a moderate risk profile.

Moreover, since his bank offers an ETF automatic investment plan that costs $15 a month for up to 7 funds at a time, he asked whether this could be attained with no more than 7 ETFs.

At first I told him he was asking for the moon. Yet, after scouring through the hundreds of funds on the market, I came up with something quite close.

First of all I worked on asset allocation: 55% in stocks, 15% in REITs and 30% in bonds seemed reasonable to me.

As for stocks, since he didn't ask for specific sectors or countries, I began looking for funds that offered the broadest exposure possible at the lowest fees, so I deemed Vanguard's ETFs would do.

I chose Vanguard Total Stock Market (VTI) for US stocks, Vanguard Europe Pacific (VEA) for European and Pacific developed countries, and Vanguard Emerging Markets (VWO) for emerging markets, which I decided to overweight for capital appreciation.

These three Vanguard funds hold thousands of stocks each, are very liquid and charge the lowest expense ratios on the market.

I thought international REITs were the best option and, using Seeking Alpha's ETF selector, I came up with a handful to choose from.

A quick comparison made me go for WisdomTree International REITs (DRW): it comprises 224 stocks for maximum diversification, has a higher dividend yield and charges a lower fee than the competition.

Finally I had to pick up one or two bond funds. My first choice was Vanguard Total Bond Market (BND); once again, Vanguard offers a very diversified fund, with thousands of securities at a very low price.

Next, I added PowerShares Emerging Market Sovereign (PCY) for exposure to emerging markets bonds. The added risk is compensated by an average dividend yield north of 6%.

Investment U has a great article making the case for emerging markets bonds.

I thought that the six funds above were the best I could offer my friend, but I decided to add another ETF to reach the magical number 7.

And here came the toughest job: what should I go for? Smallcaps? Alternative energy? Commodities?

After thinking for a while what my best option could be, it dawned on me Claymore/Zacks sector rotation fund was the solution, so I picked Claymore/Zacks Sector Rotation (XRO) to complete the list.

So here it is:

• Vanguard Total Stock Market (VTI): 15%
• Vanguard Europe Pacific (VEA): 15%
• Vanguard Emerging Markets (VWO): 15%
• WisdomTree International REITs (DRW): 15%
• Vanguard Total Bond Market (BND): 15%
• PowerShares Emerging Market Sovereign Debt (PCY): 15%
• Claymore/Zacks Sector Rotation (XRO): 10%

This portfolio has a reasonable expense ratio of 0.31%, pays a generous 3.3% dividend and an empirical back test shows it would have outperformed the S&P 500 (SPY) by more than 52% over the past 5 years.

Disclosure: none

Comments

[Long-Short Guy:]

Why 30% in bonds if his goal is capital appreciation and out-performance?

2008 Feb 10 05:24 PM

[Geoffrey Lordi:]

I agree with LSGuy - If I'd recommended 30% bonds to some of the 30-ish and 40-ish folks I work with, they'd have been displeased with my modeling. For some folks this might be fine, given average-low risk tolerance, or unique circumstances. However, I'm curious as to how you came up with that figure.

I'm not disputing your picks, though - we also own VWO, VTI, and PCY...

I'm curious to learn what your results were when you backtested with different allocations - say, 75% equities, 15% reits, and 10% bonds (and associated other derivations).

Best,
GL

2008 Feb 11 01:21 AM

[ACEMAN:]

It appears that DS has bought hook, line and sinker the propaganda that diversification is best for a portfolio. What a joke! Diversification doesn't really exists, what exists are markets and their trends, and often these don't last very long at all. But since the goal should be to make money then I have to ask: Wheres's the oil, where's the commodities, where's the gold, where is the ultra shorts on US real estate, where is the ultra short of US financials, where is the ultra short on US technology, and where is the ultra short on China! There is an old Alabama expression that expresses my ETF holdings succinctly: "Tall trees don't grow to the sky."

2008 Feb 11 11:02 AM

[granger:]

Very cool. Thank you. I enjoy exercises like that.

My portfolio is designed around the same idea, but holds much more than 7.

Check out PDP for XRO. I just made that switch recently.

Also, look at RJI. It may fill your needs for commoditis and diversification. (Given the current demographics of the world, probably some growth)

Again, good stuff, thank you.

2008 Feb 11 01:09 PM

[oldman:]

back test shows it would have outperformed the S&P 500 (SPY) by more than 52% over the past 5 years.

YES, but, what was the largest loss (drawdown) during the 5 years of holding the psotions?

2008 Feb 11 03:50 PM

[Selphone:]

Which banks offer an ETF automatic investment plan?

2008 Mar 15 02:24 PM

[Ashpak001:]

A better approach to reduce the severity of drawdowns would be to significantly increase the share of bonds (approx to 50%) at the same time aplying leverage (2 to 1 is common in most stock brokerage account) - therefore even if the basic portfolio would generate meager 10-12% the leverage would allow you to reach 20%-25% p.a. with 20% drawdowns (which could be further reduced through straightforward ATM put buying [costing 3-4% a year in premiums] or Faber-style 10-month mean-crossing method).

2008 Mar 28 04:23 AM

[Tao Man:]

ACEBOY, nice call on the ultrashorts so far...

"where is the ultra short of US financials, " -
iShares Dow Jones US Financial was 86.71 on Feb 11, now 87.36

"where is the ultra short on US technology, " -
iShares Dow Jones US Technology was 52.95 on Feb 11, now 60.09

"and where is the ultra short on China!"
iShares FTSE/Xinhua China 25 Index was 140.55 on Feb 11, now 158.1

You sure have been wrong on your criticism of diversification in favor of shorting these investments based on an Alabama expression. Perhaps the expression is useful in financial markets but good luck on the timing. Going leveraged against the market can be suicide if you get that wrong.

2008 May 15 09:59 PM

[dlgETF:]

Here is my portfolio. It is designed for a early 30's person in a taxable account. Any comments?

32.0% VTI
7.0% VB
4.0% IWC
15.0% VEA
5.0% VWO
5.0% EEB

5.0% IEF
5.0% TIP
3.0% LQD
3.0% PCY

5.0% VNQ
5.0% DRW
6.0% GSP

2008 Aug 19 12:17 PM

[david levy:]

any answer on which bank offers auto investment for ETFs?

May 21 08:33 PM