Holy Grail Portfolio: ETFs and Stocks That Form a Winning Combination

by: Lowell Herr

Eleven ETFs and four stocks make up this mosaic portfolio we title the "Holy Grail" portfolio. Establishing goals when constructing a portfolio requires assumptions based on the analysis tool used in the creation process. Guidelines for the "Holy Grail" portfolio begin with the following projections and historical data. 1) We assume the S&P 500 will increase by 7.0% over the next year. This assumption directly impacts the projected return for the "HG" portfolio. 2) Data used for the analysis will include the past three years. We could go back further, but the three-year time frame excludes the high of 2007.

The goals for the HG portfolio call for a correlation matrix that results in a diversification percentage of 40% or higher. The portfolio projected return will exceed the percentage projection of the S&P 500 by one percentage point. We seek a lower than average risk portfolio so the projected standard deviation or portfolio uncertainty will come in under 15%. The last requirement is to come up with a Return/Uncertainty ratio that will exceed 0.60.

Below are the ticker symbols and the percentages allocated to each investment. Several decisions were made during the development of the HG portfolio. No bonds were included as we anticipate interest rates will rise as will inflation. In light of that thinking we omitted bond ETFs and included 10% in TIP. The hedge against inflation resulted in the inclusion of DBC, GLD and SLV. The ultra-short SDS ETF is included as another hedge or buffer based on the current high market. While this is normally used as a trading tool, it is included in this portfolio to moderate the projected uncertainty. The four individual stocks, Abbott (NYSE:ABT), Procter and Gamble (NYSE:PG), Clorox (NYSE:CLX) and Annaly Capital Management (NYSE:NLY) also serve a similar role in this mosaic portfolio.

Running an analysis through 5/5/2011, the above portfolio has a projected return of 8.4% so it exceeds our goal of besting the S&P 500 by more than one percentage point. The projected risk or uncertainty is a low 12.8% or well below our 15% reference point. This gives rise to a Return/Uncertainty ratio of 0.66 or above the 0.60 standard. One last goal to surpass is the diversification percentage of 40% and the HG tops that hurdle by 4% points.

Below is a data table showing possible buying opportunities or guidelines for purchase. Using reversion to the mean analysis, historical data and future projections are analyzed to come up with a Delta Index.

Even though the Delta Index calls for selling a number of the above assets at this time, the combination of ETFs and individual stocks project returns superior to the S&P 500 over the next year.

Disclosure: I am long VTI, VWO, VNQ, RWX, DBC, GLD, SLV, TIP, ABT, PG, NLY, SDS.