This isn't a new idea. For any long term investor, diversification means building a portfolio with “buckets” that each contain a different investment type. There is a limitless number of investment things you can put in the buckets. There is a limitless number of possible combinations of those buckets. There is a limitless number of people and places that can tell you precisely what they believe is best to put in the buckets. I suppose this website is just one more of those places. But its suggested bucket list is based on the output of a set of learning machines, called InvestEngines.
The original InvestEngines consumed, digested, and analysed thousands of asset and portfolio years of data from many users, both individual and professional. And it regurgitated some very interesting insights. It revealed that a relatively simple approach, assisted by machine learning may be superior to the complex (and often obscure or anecdotal) approaches of the "experts". Investing isn’t rocket science and all you need are a few basic principles and self discipline to invest prudently, intelligently and successfully. It begins at the end with a simple answer.
One of the things InvestEngines exposed is that you don’t need too many buckets. Today, five are sufficient to get the necessary diversification (balancing volatility against expected returns) as well as the granularity to take your personal circumstances and market conditions into consideration. Here is one example of five buckets that get the job done.
US stocks
Ex-US developed world stocks (mostly Europe and Asia)
Emerging market stocks
Long term bonds and
Shorter term or aggregate bond funds (bonds of different term/duration)
There are many possible “other” buckets including commodities, precious metals, real estate trusts and cash. Or you could choose to have many more buckets with much finer granularity, such as large cap, small cap, growth, value, the list goes on. Alternatively you could limit yourself to 2 buckets, 1 of stocks and 1 of bonds. InvestEngines consumed thousands and thousands of asset and portfolio years of data. And the long term results were strikingly similar. The learning machines seemed to have landed on these five buckets as necessary and sufficient for most. It is a bit of a statistical sweet spot to begin with.
So what exactly should be in the buckets? Today, its probably ETFs (Exchange Traded Funds). They are very low fee groupings of a large number of individual stocks and bonds that fit within the specified category. Mutual funds have traditionally been used to fill this role as aggregates of many individual stocks or bonds, usually selected by “expert” managers. But ETFs typically offer lower fees, can be bought and sold easily, and many have been structured to capture broad market swaths that are quite suitable for our purposes. They are available from providers like Schwab, Vanguard, State Street, Fidelity and many others. A simple web search will uncover a universe of mutual funds and ETFs you can consider. Below are some quick examples of the stuff that could go into the buckets. Picking one for each bucket is a good place to start.
US EQUITY BUCKET
SWTSX, Schwab, fund, 0.03% fee
SCHB, Schwab, ETF, 0.03% fee
VTSMX, Vanguard, fund, 0.15% fee
VTI, Vanguard, ETF, 0.04% fee
EX-US EQUITY BUCKET
SWISX, Schwab, fund, 0.05% fee
SCHF, Schwab, ETF, 0.04% fee
VTRIX, Vanguard, fund, 0.43% fee
VEA, Vanguard, ETF, 0.07% fee
EMERGING MARKETS BUCKET
SFENX, Schwab, fund, 0.39% fee
SCHE, Schwab, ETF, 0.10% fee
VEIEX, Vanguard, fund, 0.32% fee
VWO, Vanguard, ETF, 0.14% fee
LONG BONDS BUCKET
VUSTX, Vanguard, fund, 0.20% fee
TLT, iShares, ETF, 0.15% fee
AGGREGATE, INTERMEDIATE, OR SHORT TERM BOND BUCKET
SCHO, Schwab, short term ETF, 0.05% fee
SCHZ, Schwab, aggregate ETF, 0.04% fee
SCHR, Schwab, intermediate term ETF, 0.06% fee
VBMFX, Vanguard aggregate fund, 0.15% fee
BND, Vanguard aggregate ETF, 0.05% fee
The annual management fees are included for comparison, because these are at the low end of the range relative to other offerings and its worth being aware of them. Fees are like taxes, the lower the better, but are worse in one way. You pay fees whether you make money or not. And considering that fees come right off the top of your investments, a 1% fee is like a 20% tax if investment returns are 5%. Your first question about any investment is; "What are the fees." The major players are continuing to lower fees, and zero fee ETF's are available.
In future articles and real-time updates I will use these 5 Vanguard mutual funds (VEIEX, VTSMX, VTRIX, VBMFX, VUSTX) to create and monitor a benchmark portfolio. These were chosen since they have the longest track record that dates back to 1993. However, many equivalent sets of funds selected from the above categories would perform similarly over the same time period. For example, these 5 ETFs (SCHE, SCHB, SCHF, SCHZ, TLT) will perform similarly over the same time period, are low fee and can be traded like stocks.
The next important step is to figure out how much you should have in each bucket, or as the investing cognoscenti refer to it, asset allocation. A discussion of asset allocation and its ramifications begins next.