Risk Reducing Retirement ETF Portfolio

by: Lowell Herr

Constructing a retirement portfolio need not be all that difficult if one selects ETFs that include broad markets and is global in its coverage. The following eleven (11) ETF portfolio is simple in its structure while providing international exposure.

The following analysis requires access to the Quantext Portfolio Planner software developed by Geoff Considine. This analysis uses four years of historical data and the S&P 500 is expected to grow 7% over the next year. One goal for the portfolio is that it will return at least one percentage point above that projected for the S&P 500. This 11 ETF portfolio meets that goal with a projected return of 8.8%.

Another goal is to hold the risk (standard deviation) below 15%. The following portfolio projects a standard deviation of 17.3% or well above our expected threshold. However, we will control the portfolio uncertainty by employing a risk reduction model. One such model was explained in detain in this article. Five portfolios are now following what I call the ITA Risk Reduction model and they are: Maxwell, Euclid, Madison, Kenilworth, and Gauss. While the Strategic Asset Allocation (SAA) plans in these portfolios vary from the asset allocation plan laid out below, the portfolios include the basic commission free ETFs that give global coverage.

The reason for using commission free ETFs is so costs are reduced when trades occur.

Correlation Matrix: Shown below is the correlation matrix for the 11 ETF portfolio. The critical eight (8) ETFs for portfolios following risk reduction model exclude the three bond - treasury instruments; TIP, TLT, and BIV. When the equity ETFs are sold, we move into bond ETFs so we will at times be holding much more than the 5% allocated to BIV, TIP, and TLT shown in the above analysis.

Note the high correlation between VTI, IWN, VEU, VWO, VNQ, and RWX. With such a high percentage of the portfolio moving in tandem, we have added incentive to use a risk reduction model to hold down portfolio uncertainty.

Investors who consider the above asset allocation too restrictive might consider the following Strategic Asset Allocation plan where the U.S. Equities market is spread out over nine asset classes. The "Big Nine" asset classes are found in the upper left corner of the following screen shot. This asset allocation plan comes from the Einstein Portfolio and readers can find more information about this portfolio on my blog at ITA Wealth Management.

Disclosure: I am long VTI, IWN, VEU, VWO, VNQ, RWX, DBC, PCY, BIV, TIP, TLT.