The Smartest High Risk Portfolio

by: Lowell Herr

Daniel R. Solin's book, "The Smartest Portfolio You'll Ever Own" is fertile ground for portfolio analysis. I've been running analysis on five "supersmart" portfolios found in Chapter 21 of his book. These portfolios run from low risk to high risk. This link will take readers to an example of a Medium-High Risk portfolio where 20% is allocated to bonds.

Each of the portfolios is skewed toward value and smaller cap ETFs. I've substituted several ETFs for those recommended by the author, as not all of his recommendations have sufficient historical data for the analysis. Value and size emphasis are evident in the selection of VOE, VBR, EFV and SCZ.

In the following high risk portfolio, zero percentage is allocated to the bond asset class. The three major asset classes of U.S. Equities, developed international markets and emerging markets are covered by VTI, EFV, and VWO. In most portfolios, I also include VEU to represent developed international markets, but I did not use VEU in this analysis.

Below is the Quantext Portfolio Planner (QPP) results for the high risk portfolio followed by weaknesses I see in this allocation plan.

The projected return of 9.3% is 200 basis points above that expected from the S&P 500 over the next few months. Without any allocation to bonds or a low correlation investment instrument, the projected standard deviation is 20%. This High Risk Portfolio has a high probability of generating a lot of volatility or uncertainty over the next year.

If we examine the correlation matrix shown below, we begin to understand why the Diversification Matrix (DM) is a very low 7%. The ETFs, while covering the globe, are highly correlated based on their behavior over the past three years. The "supersmart" portfolio that include a bond component project lower returns, but the diversification and volatility are reduced.

Another way to pull down the standard deviation or uncertainty percentage is to add a hedge ETF to this portfolio - under certain conditions. That move will also increase the DM percentage. But that discussion can wait for another article.

Disclosure: I am long VTI, VWO, VOE, VBR, EFV.

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