Model Portfolios Built with ETFs (III) - All About Asset Allocation

This is the third segment of the Model Portfolios Built with ETFs series. In the first two parts, I discussed two model portfolios, the Couch Potato Portfolio and the Bogel Head Portfolio, and considered possible choices to build these portfolios with ETFs instead of transitional mutual funds.

In this part, I continue the discussion with portfolios from the book All About Asset Allocation, by Richard Ferri，based on the presentation by Jonathan at My Money Blog.

The first model has a 70:30 stocks to bonds ratio. The detailed asset allocation is as follows:

• Total US Stock Market: 40%
• Total International Stock Market: 20%
• REIT: 10%
• Intermediate-Term Bonds: 30%

Using ETFs covered previously, we can rebuild this portfolio with the following ETFs:

• Vanguard Total Stock Market ETF (VTI)
• DJ Wilshire REIT ETF (RWR) [or Vanguard REIT Index ETF (VNQ)]
• iShares Lehman 7-10 Year Treasury (IEF)
• SPDR MSCI ACSI (ex-US) (CWI) [or Vanguard FTSE All-World ex-US ETF (VEU)]
  

Currently, there’s no total international stock market offerings in the ETF arena.

The two ETFs that cover the global stock markets are very new. State Stree’s CWI was launched early this year, while VEU from Vanguard only has less than two weeks of trading history. As for the coverage, CWI tracks the MSCI All Country World Index that includes 48 markets and VEU uses the FTSE All-World ex US Index as the benchmark. The index currently includes 50 countries.

However, this problem can be resolved by using Alternatively, we can combine two ETFs that cover the developed and developing markets. On the developed markets side, we can use iShares MSCI EAFE Index (EFA) which covers stocks from 21 developed economies. As for the developing markets, the iShares MSCI Emerging Markets Index (EEM) is a possible choice as the index consists of indexes of 25 major emerging economies. Alternatively, we can also use Vanguard Emerging Markets Stock ETF (VWO) to replace EEM. Some key data for EEM and VWO are:

The second portfolio also has 70% in equities and 30% in bonds, but is more diversified than the first one:

• Total US Market: 25%
• US Small-Cap Value: 10%
• US Micro-Cap: 5%
• REIT: 10%
• Pacific Market: 5%
• European Market: 5%
• International Small-Cap: 5%
• Emerging Markets: 5%
• Intermediate-Term Bonds: 10%
• High Yield Bonds: 10%
• Inflation-Protected Securities (TIPs): 5%
• Emerging Market Bonds: 5%

In addition to the ETFs mentioned above, this portfolio can use the following funds:

• Vanguard Small Cap Value ETF (VBR)
  
• iShares Russell Microcap Index (IWC)
• iShares MSCI Pacific ex-Japan (EPP)
• Vanguard European Stock ETF (VGK)
• iShares Lehman TIPS Bond (TIP)

While there are plenty of equity ETFs for us to choose from, the bond offerings are very limited and most of them track various Lehman bond indexes. As a result, I wasn’t able to find appropriate bond ETFs in the high yield and emerging market areas. Hopefully, this situation will change soon as Vanguard is preparing to its own bond ETFs.

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3. Model Portfolios Built with ETFs (I) — Couch Potato Portfolio
4. Asset Allocation: What It Is and Why It Is Important
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