I’m 25 and starting to invest for my retirement and other long term goals, My investment horizon is more than 20 years. (This long-term portfolio contains stocks only. I do own bonds in another account.) My goal is to keep it simple and own a diversified stock portfolio with as few funds as possible. My plan is to invest passively with Vanguard index funds, since I appreciate their low costs and the ‘Boglehead’ way of investing. I invest about $500 a month.
Here’s my asset allocation:
• 40% global stocks
• 10% European stocks
• 10% Japanese stocks
• 20% Emerging Markets stocks
• 20% Global small-cap stocks.
My aim is long-term growth, so I want to own diversified stock market funds world-wide instead of just chasing high past returns. (For example, the U.S. stock market has had very high past returns over the last 10 years, and Japanese quite low returns.) The global stock funds (both large-cap and small-cap) have almost 50% of their funds allocated to the U.S. That’s why I added the other funds, and I haven’t allocated any money to an S&P 500 fund.
Can you suggest any improvements or critiques to the above mentioned asset allocation?
This is the question posed recently by do-it-yourself investor (I’ve paraphrased his post for readability.)
The conventional wisdom on Wall Street is heavy on U.S. funds and either light, or even nonexistent, on international and emerging markets. Many ordinary investors have all of their money in the S&P 500
index of large U.S. stocks, for example through the SPDR S&P 500 ETF Trust
This was so unusual and so intriguing I asked some financial planners for their take.
“Substantial underweighting of the U.S. is sort of puzzling,” says Chris Chen, a financial planner at Insight Financial Strategists in Newton, Mass. The U.S., he says, “remains a key driver of growth and innovation.” He also wondered about the overweight positions in Japan and Europe. But on the other hand, he liked the big bet on emerging markets. “Emerging markets are widely seen as an important source of long-term growth; 20 years should be enough to see a payoff.”
And Leslie Beck, a financial adviser at Compass Wealth Management in Rutherford, N.J., recommends the investor do a “holdings ‘X-ray’” to work out what they really own. That means looking at where the different fund holdings’ overlap, to find your overall allocation. For example, depending on the two global funds used, someone with this strategy could easily end up with, say, 20% of their portfolio invested in Japan, 25% in Europe and 30% in emerging markets. “I would consider this an aggressive portfolio, but if you have strong feelings about overseas growth, a weaker U.S. dollar, a growing Japan, and a long term outlook, who knows?” she adds.
“This is an unusual portfolio allocation and not appropriate for most investors,” warns Larry Luxenberg, a principal at Lexington Avenue Wealth Management in New City, NY. “Without knowing more about the individual, it’s impossible to know whether this is appropriate to him but it would not fit the risk profile of most investors.”
And Monica Dwyer, a financial adviser at Harvest Financial Advisors in West Chester, Ohio, notes that the portfolio holds comparatively little U.S. stock. “The U.S. stock market has, over a long period of time, outperformed international stocks with less volatility,” she says. “I would advise against this portfolio. You are adding risk and the return isn’t even there to justify it.”
But let’s take the other side of the argument. First, let’s point out all the things the investor is doing right. He’s starting his investments young. That alone can make a gigantic difference. He’s focused on long-term performance over short-term fluctuations. He’s disciplined, investing a regular amount in his portfolio every month, and not trying to time the market. He’s not chasing past winners. Whether or not you like his asset allocation, he’s certainly diversified. And he’s controlling the amount of his investment dollars that go on expenses by using low-cost index funds. (They don’t have to be Vanguard.)
These are all gold-star investment strategies and tactics.
As for that asset allocation? Maybe it’s not as crazy as it appears at first blush. It’s still about 30% invested in the U.S. That’s far more than in any other country. And it’s about twice the U.S. share of world economic output. According to the International Monetary Fund’s latest numbers, the U.S. share of world output, measured in purchasing power terms, has fallen from 21% in 2000 to just 15% today. You could argue U.S.-based stocks, which account for nearly 60% of the world’s stock markets by value, are overvalued today compared with others.
I ran the numbers on this portfolio going back 20 years, using MSCI indexes for the various allocations, and comparing it to the S&P 500.
Bottom line? Over two decades this portfolio, rebalanced quarterly, has done pretty well. It actually led the S&P 500 by a wide margin over most of that time, has gained 144% in total including dividends. The U.S. large cap index, which has gained 160%, only caught up in the last couple of years.
Of course, past performance is no guarantee of future results. There is nothing to say the U.S. stock market will outperform overseas rivals over the next 10 years as it has over the last 10. Indeed, logic and history would make you wonder. U.S. stocks have often beaten overseas markets for decades at a time—and vice versa. Today U.S. stocks are at levels—or example, compared with total GDP — that should raise some concerns. The last time large U.S. stocks were this dominant in the global indexes was in 2000.
And for those who have forgotten their history: That was the point at which they proved a suckers’ bet, and the smart move was to have your money spread around the world.
Personally, I’d rather hold this portfolio than just the S&P 500. But that is the thing about markets. You pays your money and you takes your chances.