Model Portfolios Built with ETFs (II) — The Boglehead’s Guide To Investing

This is the second part of the Model Portfolio Built with ETFs series, which convert Jonathan’s Model Portfolios into all-ETF portfolios. In this part (the first part can be found here), I looked at the four example portfolios in The Bogleheads’ Guide to Investing [Amazon.com affiliate link] and examined ways to reconstruct these portfolios using nothing but exchange traded funds.

There are four asset allocation models in the Boglehead book, based on an investor’s time horizon to retirement. A general rule of thumb is that when investors have time on their side, they can afford to take a greater risk with a bigger portion of their investments in equities, as it has been proved (using historical data of course) that over long-term, equities offered investors better returns than bonds did. As the time span gets shorter, however, the investments shift to a more conservative allocation with a higher percentage in fixed income assets. This basically is the theory behind the lifecycle funds. If you prefer to invest in funds of your own choices (with lifecycle funds, this flexibility is gone) and adjust the asset allocation yourself, then the Boglehead models provide a guideline of what a portfolio looks like at different stages: young, middle aged, and in retirement.

Young investor model

• Domestic Large-Cap Stocks: 55%
• Domestic Mid-/Small-Cap Stocks: 25%
• Intermediate-Term Bonds: 20%

The young investor model has 80% in equities and 20% in bonds, a typical allocation for investors early in the accumulation stage. Personally, I feel that a even greater exposure to equities such as 90% is possible if there are some 20, 30 years before reaching retirement. And considering the excellent growth rate of small-cap storcks (above picture is a comparison between Russell 2000 index [blue] and S&P 500 index [red] for the past five years), the mid-/small-cap stocks can take a bigger share in the asset allocation. For this portfolio, an all-ETF scenario could be:

• iShares S&P 500 Index (IVV)
• iShares Russell 2000 Index (IWM)
• iShares Lehman 7-10 Year Treasury (IEF)

Some key numbers of these ETFs are:

Middle aged investor

• Domestic Large-Cap Stocks: 30%
• Domestic Mid-/Small-Cap Stocks: 15%
• Diversified International Stocks: 10%
• REITs: 5%
• Intermediate-Term Bonds: 20%
• Inflation-Protected Securities, or TIPs: 20%

For middle aged investors, the allocation of the Boglehead model, while still tilting towards equities, has a bigger share in fixed income assets. Altogether, the bond portion of the middle aged investor models accounts for at least 40% of the total assets. The choices of ETFs for this portfolio model include:

• iShares S&P 500 Index (IVV)
• iShares Russell 2000 Index (IWM)
• iShares MSCI EAFE Index (EFA)
  
• DJ Wilshire REIT ETF (RWR)
• iShares Lehman 7-10 Year Treasury (IEF)
• iShares Lehman TIPS Bond (TIP)

For investors who are in the retirement, the focus becomes assets preservation and income generation, while still participating moderately in the stock market for potential asset growth. As it can be seen, the main feature of the following two models is that fixed income investments are now the majority, making up 60% to 80% of the total assets.

Investor in early retirement model

• Diversified Domestic Stocks: 30%
• Diversified International Stocks: 10%
• Intermediate-Term Bonds: 30%
• TIPs: 30%

Late retirement investor model

• Diversified Domestic Stocks: 20%
• Short-/Intermediate-Term Bonds: 40%
• TIPs: 40%

Alternatively, some of the above mentioned ETFs, mainly iShare ETFs, can be replaced by offerings from Vanguard to further reduce costs. Possible candidates include:

• Vanguard Small-Cap ETF (VB)
• Vanguard Mid-Cap ETF (VO)
• Vanguard Total Stock Market ETF (VTI)
• Vanguard REIT Index ETF (VNQ)

The only problem now for Vanguard ETFs is the lack of tracking record as they are relatively new, compared to iShare ETFs. However, given Vanguard’s reputation in the mutual fund industry (though I had some horrible experience with them), investors can expect Vanguard ETFs to perform very well with rock bottom costs.

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