Building a Core Portfolio
Market movements since March 2020 have been a bit crazy and unless you have been in hiding, I’m sure you’ve heard something about the price of Tesla stock, Robinhood.com traders and of course Bitcoin. So with all that going on, you can end up like a deer in the headlights, frozen with fear and not knowing whether you should invest now, wait for a crash and then go in, or just stay away from it all.
The key to this avoiding this sort of thinking is to set up a “core portfolio allocation”. This should be something that you don’t really worry about on a day to day basis, because it is well diversified and will more or less be okay, letting you ignore the short term noise.
Asset Allocation
I also thought that I should be quite specific with this allocation, so as to give you a template for what to do. If you want to do something slightly different, that is fine, but below is what I have done. I’ll explain the logic behind each of the specific stocks/ETFs in this portfolio, and then go through a performance comparison.
So here is the general rationale for this portfolio. The first three I think of as U.S. focused allocations, in aggregate about 40% of the allocation. The first 25% is in the S&P500 which consists of the largest 500 companies in the U.S. I’ve then added a 5% allocation to U.S. Small Cap stocks as you would otherwise miss this exposure. I also add Berkshire Hathaway to get some exposure to value stocks. Berkshire is Warren Buffet’s company and while he may not make you gobs of money like the Tech Sector ETF, he careful and won’t lose you money either, so I think BRK will provide some downside protection in difficult markets.
From there, the other parts of the core portfolio include a 20% exposure to international stocks (ex-U.S.), a 10% exposure to Tech stocks, which to me are more global in nature anyway, so I include them in more of an international exposure bucket. Then last 3 positions, the Metals and Mining ETF and the U.S. and non-U.S. Real Estate are very much diversifying exposures, as they tend to perform differently from typical core U.S. stock investments.
One thing that I have left out of this portfolio is exposure to any kind of bonds. The problem with U.S. government bonds (and for that matter bonds of any developed market) is that they are providing very low returns recently. To me there really is no point to invest in government bonds, at least at this time — when U.S. 10-Year Government Bond yields go back to 3%, you can consider investing in them, but for the next year or two that’s probably not happening and so I would not bother with bonds.
Core Portfolio Performance
So how has this portfolio performed through 2020 and (if we go back further) during the past 10 years?
No surprise that XLK, the Technology Sector ETF had the best performance for 2020. The S&P 500 ETF also did very well with a 16% return. And November overall was a good month.
When we apply the weights, what we end up with for the year, is a 10.7% portfolio return. While not the 41% return that we would have had if we had put it all in Tech Stocks, it is better diversified against big losses also.
Over the past 10 years, this portfolio would have generated a 110% return. When we compare that to the individual investments (shown below), you see that this return is much lower than the 198% return that the S&P 500 would have generated, or the over 400% return that the XLK technology portfolio would have made.
So why bother investing in this portfolio if it underperforms the overall U.S. market? Two reasons. First, the past 10 years have been great for the U.S. stock market, so anything looking back 10 years that has a higher U.S. allocation will alway look better. But the future is not the same as the past, and the U.S. may not have the same outperformance in the next 10 years. The second is that you want your core portfolio to be something that lets you sleep at night. When the U.S. market goes down, you want something that is helping the portfolio on the other side, by hedging your bets to some extent.
In the end, there is no perfect portfolio, and you can do any other combination that works for you. My point in providing this template, is so that you have something to start with. The broader lesson here is not to be that deer in the headlights and to go ahead and do something. Most combinations of these investments will outperform your bank savings account over any significant period — that should be enough of a reason to do it.
What Next?
I’m going to track the performance of this portfolio over the rest of the 2021 to see how it does. This is not a get rich quick scheme, but the idea is also not taking on so much risk that it leads to ruin.
In the end there will never be a perfect time to invest. Or a perfect portfolio allocation. Take a measured approach to invest for the long term and try to tune out the noise from all the speculators.