The Boglehead’s Guide To Investing Portfolio Built with ETFs

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 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%

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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 stocks (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 (all data from Morningstar.com):

Symbol ER Yield (%) 1-yr return (%) 3-yr return (%)
IVV 0.10 1.65 15.89 10.24
IWM 0.20 1.05 12.75 12.95
IEF 0.15 4.25 4.24 2.55

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)
Symbol ER Yield (%) 1-yr return (%) 3-yr return (%)
EFA 0.35 2.09 26.12 19.65
RWR 0.26 2.92 38.93 29.69
TIP 0.20 4.32 1.57 2.89

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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4 Responses to “The Boglehead’s Guide To Investing Portfolio Built with ETFs”

  1. Moneymonk |  Feb 21, 2007 at 4:22 pm

    Wow! your post could have came at a better time, I was just thinking of what bonds will be good for my age. I am just getting around to funding my Roth IRA.

    I had WIA, but I decided to get IEF instead. And VNQ is during very well.

  2. Lazy Man and Money |  Feb 21, 2007 at 4:23 pm

    I prefer VTI and VB for their low cost structures. I have no worries about the actual performance of them. To me, an index fund is more or less an index fund over the long haul.

  3. The Sun |  Feb 21, 2007 at 5:40 pm

    As of bonds, IEI may be another choice as it’s truly an intermediate bonds (3- 5 year duration) but it has been around for only a month, so there’s no tracking record to back it up. And Vanguard ETFs should also deliver solid returns, despite their short history. It’s hard to imagine that they do so well with mutual funds, but would do poorly with ETFs.

  4. db |  Feb 23, 2007 at 12:13 am

    These all seem a little low on international funds to me — just a matter of personal taste perhaps.

    Oh — and some very exciting news for the Vanguarders out there. In late Dec Vanguard filed paperwork to offer a new “international ex-USA”, so there will be another international ETF choice. This one will include Canada, which is typically left out of international funds (and it will give people a choice for a single international ETF).

    And in Jan Vanguard filed paperwork to offer some new bond fund ETFs, including one that will mirror the Total Bond index fund.

    Word is both of these should be available sometime in the first part of the year, pending SEC approval.