- Most investors tend to beat index S&P500 no matter what. Not beating the index means total failure for them.
- But there are many who are satisfied with "lower" results with low volatility.
- Nonetheless, there is still way to beat the index, even with low volatility portfolio. Beating the index doesn't necessary mean to have best performance ever.
- Before you will read more, remember that this type of investment is completely passive and doesn't need any additional work. Almost!
Last week I was talking to my friend and by a chance we spoke for a while about passive investing. He told me that he would've liked to invest 25% of his salary, but unfortunately he didn't known how. Respectively, he didn't know in what to invest. He also added that he would not like to see how easily could his portfolio lose its value.
He asked me, if there is a way to invest passively and have solid returns, perhaps even beat the index?
As he is my friend and I am eager to help him, I decided to create some kind of low volatility portfolio with a high interval of single-digit returns. Having at the book written by Jeremy Siegel, called "Stocks for the Long Run" and I have utilized comparisons of stocks vs. bonds on the 200y history of the market.
Was I able to discover that portfolio? Let's find out!
Low volatility portfolio
I named that portfolio "Will 1" and reason is simple. I took my name. Hahaha. "Will 1" is also the most conservative. Soon I will try to redevelop that and create two more portfolios - "Will 2" and "Will 3".
Composition of "Will 1" is in the table below.
|US total stock market||38|
As you can see above it is pretty simple composition based on 45% in the stock market, 40% in US bonds and 15% in gold. Because the "Will 1" should be completely passive, I am going to use just ETF's. Important thing is rebalancing annually to follow exact percentage composition!
In case of stock market, I decided for US total stock market ETF like
Both are quite the same, but I intend to invest in Vanguard. Reason why I choose these two ETF's is that I don't want to be fully engaged in large caps. I believe mid caps or even small caps have high potential to get to large caps and while I invest in whole market, I am able to track those results/performances better.
In case of REIT I choose
Reason why I am choosing REIT to "Will 1" is because REIT ETF's provide relatively high dividends which could be used for automatic reinvesting, so in the annual rebalancing it will provide additional capital.
In case of US bonds I choose these two ETF's
I see US bond market as the most stable one with reasonable growth and optimal complement against US stock market.
In case of gold I choose
- SPDR Gold Trust ETF (GLD)
Overall I use 5 ETF's which I believe would cover everything I need in "Will 1" portfolio to achieve solid results.
Backtest of the "Will 1" portfolio
For backtesting I am using Portfolio Visualizer which very well serves my needs. As comparison against "Will 1" I am using Vanguard 500 Index Investor (VFINX).
As you can see above, "Will 1" portfolio has delivered overall returns in 26 years (exactly from 1994 to 2020) 8.67% CAGR. $10,000 invested in the 1994 would be worth now around $94,000. Overall not bad!
Now, there are few things you can suggest.
- "Will 1" didn't beat the index at all,
- "Will 1" made obviously less money than index.
Overall it is true, but I am going to defend it in the next pictures. Main purpose of "Will 1" portfolio is low volatility. As you can see below, volatility of "Will 1" was extremely low over the time. It is almost a straight line. Standard deviation in 26 years was around 7.58% against 14.95% of the index. The worst year of the "Will 1" was negative 7.22% (max drawdown negative 18.26%) against negative 37.02% (max drawdown negative 50.97%). So here is the first win against the index.
Historical drawdown during main financial crisis you can see below.
As stated above, there is a composition of returns by single assets. Obviously US Stock Market did most of the job, but return from long-term US bonds did fine as well.
The most interest thing you can find below. It represents annual returns over the exact time frames. First you can see is that "Will 1" has delivered extremely stable results. Interesting thing is that if we would have been in the low interval of performance, from 5y and more we wouldn't have seen negative returns at all. That could be considered as the second win.
Lastly what I want to point out is that the "Will 1" portfolio has beaten the index on average by almost 1.8% in the 15y time frame, by 1.4% in the 10y time frame and by 0.7% in the 7y time frame. I consider that as the third win of the "Will 1" portfolio against the index.
"Will 1" portfolio isn't for those who are looking for beating the index every year by xx%. "Will 1" portfolio is for those who are not too much knowledgeable in investing, want decent high single-digit return and prefer to have very low volatility.
"Will 1" shows on proofs that it is capable of beating the index with very stable return of 8% with extremely low volatility over the time.
Last words would be that I am very confident that this type of portfolio will do quite well in the future.
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