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Summary The aggressive allocation strategy incorporates a mere 15% of the portfolio to bonds. The portfolio also contains 8% to utilities and 25% to equity REITs which are sensitive to movements in interest rates. This kind of portfolio is designed for an investor that can bear substantial risk and is willing to have the portfolio rebalanced at regular intervals. I’ve selected a combination of the Schwab and Vanguard funds that I find attractive. Several are in my portfolio. Facing expectations for an increase in domestic short-term rates, portfolio strategy has been on my mind. Frequent readers will know that I cover mREITs a great deal and invest a material portion of my portfolio in the mREITs that I consider most attractive. In this piece, I want to talk about a strategy that I think would be very reasonable for the rest of the portfolio. Before we get into the allocations, I want to stress that this is designed as an aggressive portfolio and for many investors, this portfolio would simply be too risky. I have a long-time horizon, and aggressive allocations make sense for me. Each investor should carefully consider their circumstances. The Strategy I feel that a portfolio like this would be most useful under MPT (Modern Portfolio Theory). The portfolio would be designed with the expectation of frequently rebalancing positions. That can be a problem for investors that are holding their positions across several accounts or don’t have free trading on the securities. Several of these ETFs will qualify for free trading through either Schwab or Vanguard but not both. I’d love to see each of those brokerages bring out additional funds to make it possible for an investor to select funds from only one brokerage for this strategy. It might be possible through Vanguard, but I’m more familiar with Schwab’s international options. Tax Exempt For the purpose of this article, I’m assuming the accounts are retirement accounts that are tax exempt. Some investors may figure that this would be a problem because the employer sponsored 401k is unlikely to have all of these options, but I’ve personally had success with rolling former employer 401k accounts into IRA accounts. The heavy weight for domestic equity REITs would be fairly strange for an investor facing higher income taxes on the position. Asset Allocation That domestic total allocation of 65% could be treated as a home country bias and there may be some arguments for moving that combined position down to 60% of the total portfolio so that international positions and bonds can be increased. For now, I’m going to go with 65% in the combination of domestic equity and domestic equity REITs. Many investors may think 40% into traditional equity with 25% into equity REITs is incredibly heavy on equity REITs, but I see the lack of corporate taxation as a huge and durable advantage for providing superior growth. Domestic Equity The first 40% gets broken up between three funds: I’ve used the Schwab U.S. Broad Market ETF (NYSEARCA: SCHB ) over the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) on the basis of a .01% lower expense ratio. This is fairly small, but I’m long both ETFs in different accounts. I’m also using the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) and love the defensive allocations. In this case, I opted to use the broad market ETF because I’m combining it with the Vanguard Consumer Staples ETF (NYSEARCA: VDC ) and the Vanguard Utilities ETF (NYSEARCA: VPU ) to make the combined domestic equity position significantly more defensive. Equity REITs This is fairly simple. Investors could use the Vanguard REIT Index ETF (NYSEARCA: VNQ ) or the Schwab U.S. REIT ETF (NYSEARCA: SCHH ). For investors seeking higher dividend payouts, the easy answer is VNQ. Since I have a very long time until the retirement and the portfolios are very similar, I’ve been adding more to my SCHH holdings since it has free trading a lower expense ratio. International As I noted at the start of the article, I’m more familiar with Schwab’s international options than with Vanguard’s. The Schwab International Equity ETF (NYSEARCA: SCHF ) gets only 5% of the portfolio and matches the Schwab Emerging Markets ETF (NYSEARCA: SCHE ). The heaviest weight goes to the Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) because I want the international equity allocations to favor smaller companies on the assumption that they will earn more of their revenues from the international market. I don’t have much use for overweighting multinational companies that happen to have their headquarters in a different country. Therefore, I prefer the smaller companies in this space. Bonds I went with a mix of the Schwab U.S. Aggregate Bond ETF to get very high credit quality (including treasuries) and fairly moderate duration and the Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ) for a higher yield. The long duration on high credit quality corporate issues allows the fund to still exhibit a negative correlation with the S&P 500 while offering significantly stronger yields than treasury securities of the same long maturity. One Problem Using a portfolio like this would be ideal for an aggressive investor that is ready to put a rebalancing plan in place. Some of the brokerages will offer options to create an automatic portfolio and will allow users to influence the allocations. When I tested out Schwab’s feature for it, I was disappointed to find that some of my favorite Schwab funds were not included in the options. Of course, Schwab also does not have an equivalent option to VDC or VPU in its group of funds with extremely low expense ratios. If it rolls out an option that would allow automatic rebalancing across the account with my favorite ETFs included, I would be very interested in trying it. I wouldn’t want to incorporate my mREIT positions into that part of the portfolio, but I would feel comfortable designing a weighting system for the rest of my portfolio that would be automatically rebalanced. One of the funds I was disappointed to see excluded from the system was SCHH. Since this kind of rebalancing system would be problematic outside of tax-exempt accounts, I would really want to be able to run a heavy equity REIT allocation. Conclusion I’d love to see brokers continue to develop their portfolio management tools so that it is simple for investors to set up a portfolio like this. They would need to be careful about handling things such as rebalancing and allow investors to set a goal like to rebalance individual positions when the bid-ask spread is only one cent. Scalper1 News
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