Asset Classes: How Many Should You Own?

by: Lowell Herr

With much recent attention given to answering the money manager's most perplexing question, what percent of the portfolio should be invested in each asset class, the whole idea of how many asset classes to include in a portfolio has been neglected. William Bernstein answers the question this way. "You might as well ask the meaning of life. About all one can say is, more than three." The major three would be equities, bonds, and cash. However, that does not provide a well-diversified portfolio.

Many of the ITA Wealth Management Portfolios hold as many as 18 asset classes (including cash) if one breaks the U.S. Equities market into the "Big Nine." If I were to answer the above question I would recommend between seven (7) and nine (9) at a minimum. Here are my recommendations.

  • U.S. Equities
  • Developed International Markets
  • Emerging Markets
  • Domestic REITs
  • International REITs
  • Commodities
  • Domestic Bonds & Treasuries
  • International Bonds
  • Cash

Precious metals can be considered a separate asset class or be included under the commodities umbrella.

What ETFs might one use to populate the above asset classes, excluding cash? To answer the question I'll walk readers through an optimizer analysis. First the efficient frontier, followed by a ranking so the individual ETFs are identified, and then on to the buy-hold-sell worksheet.

Efficient Frontier: The optimized portfolio is just off the graph in the upper right-hand corner of the following graph. Based on the shares I selected for each ETF in this sample portfolio, the portfolio merits a little tweaking to reach full optimization.

ETF Rankings: The following list of ETFs will cover all eight primary asset classes. The "Big Six" U.S. Equities asset classes are broken down into VTV, VOE, VBR, VUG, VOT, and VBK. These are all Vanguard ETFs. In addition, the total U.S. Equities market is covered by VTI. If a money manager wanted to hold to 20 ETFs, but needed to make room for a special ETF such as DVY, my suggestion is to eliminate a bond ETF such as BIV, LQD, or JNK.

Buy-Hold-Sell Ranking Filter: The number of shares for each ETF was selected at random so I was not following any specific Strategic Asset Allocation (SAA) plan. If the current held shares was aligned with the SAA, then some adjustments are in order.

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