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Prevention Is Better Than Cure

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April 07, 2011 – Comments (0) | RELATED TICKERS: VTI , BND , VEU

The disaster is Japan is still fresh in our minds even as the disaster in New Orleans becomes a distant memory. Both are vivid demonstrations of the fact that the cost to repair dwarfs the cost to prevent. If only is the dominant regret. Like New Orleans where the levies were known to be a problem area, Japan's nuclear reactors were living on borrowed time, having had their life extended -- just another year. The temptation to delay until next time is very seductive until disaster strikes.

For years we have put off dealing with our retirement investment for -- just another year. Many now face the same repair crisis in their portfolios as they are left with a hole that they have to fill somehow. The good news is that there are actions you can and must take to repair the damage and make the most of the time you have left.

To outline steps you can take, we are going to use a simple benchmark vehicle -- SIB -- Simpler Is Better to show the potential difference in returns between the portfolios with different numbers of asset classes.

Each of the SIBs are built from one ETF per asset class. The ETFs we selected for these portfolios are as follows:


VTI Vanguard Total Stock Market

VEU Vanguard FTSE All-World ex-US

VWO Vanguard Emerging Markets Stock

VNQ Vanguard REIT Index

DBC PowerShares DB Commodity Idx Trking Fund

BND Vanguard Total Bond Market ETF

The three asset SIB has (VTI), or (SPY), (VEU) or (EFA) and (BND) or (AGG). The four asset SIB adds emerging markets (EEM) or (VWO). The five asset SIB adds Real Estate (RWR) or (VNQ). The six asset SIB adds commodities (DBC) or (GCC).

The three asset portfolio is old school. The world comprises the US and the rest. US equities are enough of a microcosm that I can find enough diversification to give me protection against certain segments of the markets declining. Even if that does happen, I have fixed income and international equities to bail me out. We know that this is no longer the case. We can see on our browsers how the DOW, FTSE and NIKKEI act as if they are the same index, just on a different timezone. With a three asset portfolio, you really have very limited diversification.

Four asset classes add emerging markets which provides an equities asset class that behaves differently from US and international.

Five asset classes provides real estate trusts which moves away from equities and provides an asset that delivers dividends and is uncorrelated.

Six asset classes provides commodities which is a great hedge against inflation and also times of international stress when equities can drop sharply.

 

If we take the difference in returns between the three asset class portfolios and the 4-6 asset class portfolios and assume they are the same for ten years, we couild end up with and extra 137%  more in our portfolios -- more than double!

Portfolio                                                                                             5yr AR     10Yr Extra

                                                                                                                        Money

Six Core Asset ETF Benchmark Tactical Asset Allocation Moderate           13%      137%

Six Core Asset ETF Benchmark Strategic Asset Allocation Moderate           7%       34%

Five Core Asset ETF Benchmark Tactical Asset Allocation Moderate          10%       79%

Five Core Asset ETF Benchmark Strategic Asset Allocation Moderate           6%       22%

Four Core Asset ETF (EM) Benchmark Tactical Asset Allocation Moderate    8%       48%

Four Core Asset ETF (EM) Benchmark Strategic Asset Allocation Moderate   5%       22%

Three Core Asset ETF Benchmark Tactical Asset Allocation Moderate 4% -
Three Core Asset ETF Benchmark Strategic Asset Allocation Moderate 4% -

Unfortunately, most portfolios in retirement plans only support three asset classes. In a study of over 800 mainly retirement plans, we noted that the majority of plans supported only three asset classes which is going to have a significant impact on the potential returns for the participant.

How can  you do this if your plan only supports three asset classes? If you have an IRA, overweight the missing asset class (or two) in the IRA to compensate and create a more balanced portfolio that can deliver higher returns and lower risk.

Prevention is better than cure, which we all know. Just don't leave it -- one more year -- until you get started.

 

Disclosure:

MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical. 

 I am long in DBC but receive no compensation for mentioning the ETF 

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