Some Portfolios May Be Too Diversified

Is a U.S. stock/bond mix sufficient for most people to reach their retirement goals? Morningstar has addressed this question by creating seven portfolios, each more diversified than the previous one. Returns for the 20-year period ending June 2014 are shown in the table below. It turns out a simple 70/30 mix (S&P 500 + government bonds) is difficult to beat. Each of the seven portfolios was rebalanced at the end of each calendar year.

 

Portfolio Annualized Returns [all periods ending 6/30/2014]

 

Portfolio	20 years	10 years	2008 return
[1] 70/30 (U.S. stocks / U.S. bonds)	9.1%	7.6%	-25.2%
[2] 55/30 + 15% foreign stocks	8.6	7.6	-26.1
[3] 55/30 + 10% foreign stocks + 5% emerging markets	7.8	8.8	-33.1
[4] 55/20 + 10% foreign stocks + 5% emerging markets + 10% foreign bonds	8.7	7.9	-26.7
[5] 50/20 + 10% foreign stocks + 5% emerging markets + 10% foreign bonds + 5% REITs	8.8	8.0	-26.7
[6] 45/20 + 10% foreign stocks + 5% emerging markets + 10% foreign bonds + 5% REITs + 5% commodities	8.6	7.7	-26.1
[7] 40/20 + 10% foreign stocks + 5% emerging markets + 10% foreign bonds + 5% REITs + 5% commodities + 5% hedge funds	8.6	7.6	-25.2

Source: WSJ (August 16-17, 2014) + Morningstar

 

Including government bonds can be helpful; in 2008, the Wilshire 5000 returned -37% vs. -25.2% for the 70/30 mix. While the 70/30 mix was the best performing portfolio over 20 years, the 55/30/10/5 mix (stocks/bonds/foreign stocks/emerging stocks) was the winner for 10 years.

 

According to the WSJ, “Some corporate pension funds and university endowments missed much of the stock rally of the past five years because they bought in big time to private equity and other alternative investments.” A fully diversified global stock and bond portfolio can be created using just three indexed ETFs: [1] total U.S. stock market, [2] total U.S. bond market, and [3] total foreign stock fund.

 

Simple can be practical

More funds added to a portfolio means more rebalancing. Do you want to rebalance a 5% REIT holding when it becomes 5.7% of the portfolio? Moreover, the more basic the portfolio, the more likely the investor can understand their holdings which may translate into a client more likely to stay the course.