Friday, March 31, 2006

An All ETF Asset Allocation Portfolio

In my series on asset allocation, I mentioned in passing that my ETF account #1 (see here) was based on the ETF buy-and-hold model portfolio from Paul Merriman (scroll down to the bottom of the page). I will go into a little more detail here. The portfolio consists of 8 ETFs, 4 for the domestic market (RSP, IWD, IWN, and IWC), 2 for the foreign market (EFA and EEM) and 2 for bonds (AGG and SHY). For a more detailed discussion please see my series on asset allocation and Paul Merriman’s website. The following table shows the current and target weighting in the portfolio.

Note Merriman updated his portfolio recently and replaced some iShares with the equivalent Vipers, presumably due to their lower fees. In particular, IWD, IWN, and EEM were replaced with VTV, VBR and VWO respectively. The difference in fees is small and the Vipers are less liquid. Further more, the Vipers have a short history and I cannot judge if they are better than the iShares in terms of tracking error even though the Vanguard mutual funds may be. So for now I would characterize the change as a matter of principle rather than a practical necessity. Other than replacing SPY with RSP as justified in this post on index investing, I have kept the allocation untouched, including the 60/40 equity/bond split that is on the conservative side for us.

I was able to convince my wife to devote $30k to this portfolio on Sept 8 of last year. Here is a summary generated by Microsoft Money in which the %gain is calculated on a total return basis, i.e., including the dividend payments. The period of performance was Sept 8, 2005 to March 31, 2006.

You can see the two bond funds were essentially flat after taking into account all the dividends, while all the equity ETFs made nice gains. Leading the pack was EEM, the emerging market ETF which picked up 23%, followed by EFA, the foreign developed market ETF at 15.4%. Double digit gains were also posted by IWC and IWN, the microcap and small value ETFs. This is just a more quantitative way of saying that for the past year, foreign and small cap stocks were the place to be. Overall, the portfolio gained 7.97% in close to 7 months, which is 15.3% annualized. Not bad considering the heavy fixed income component.

The 60/40 equity/bond split is too conservative for a young investor. If this portfolio were our main investment outlet, I would consider reducing the bond component to 30% and add 5% each of IGE (iShares GS natural resource) and GLD (gold) to make it a 10 ETF portfolio. More adventurous souls may further replace some bond component with REITs (ICF, IYR or the like) that should do well in the long term.