You have to hand it to Burton Malkiel. A year ago we asked the Princeton professor and two other experts to suggest simple, low-cost portfolios that relied heavily to exclusively on index funds. The idea was to show that you don’t have to use fancy investments to earn a good return. The results are in, and Malkiel thumped the market. From the beginning of the simple-portfolios project on January 1, 2009, through February 28, his portfolio advanced 40% -- well ahead of the 26% return of Standard & Poor’s 500-stock index for that period.
A healthy allotment to foreign stocks, particularly those from emerging markets, helped goose Malkiel’s gains. Leading the way were 10% stakes in both Matthews India (symbol MINDX), a regular open-end mutual fund, and Templeton Dragon (TDF), a closed-end fund (one that issues a fixed number of shares and trades like a stock). The funds soared 95% and 51%, respectively.
Malkiel says he chose these funds, both of which are actively managed, because he saw them as the best way to play China and India. Those countries, in his view, are likely to remain among the world’s fastest-growing economies. He chose the Templeton fund specifically because a year ago it traded at a big discount to the value of its underlying assets. As of the March 8 close, with the shares at $25.54, the fund traded at a 10.8% discount to net asset value per share.
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Malkiel is the author of the classic book A Random Walk Down Wall Street (W.W. Norton & Co., $19). And in his most recent book, The Elements of Investing (Wiley, $20), with co-author Charles Ellis, Malkiel covers what he calls “the timeless lessons of diversification, minimizing costs and rebalancing.”
Under the ground rules of our contest, all portfolios are automatically rebalanced once a year at year-end. In addition, the experts are permitted to alter their portfolios once a year, although Malkiel is standing pat. Here are the results of his portfolio from January 1, 2009, through February 28, 2010. The portfolio was rebalanced on December 31, 2009.
Malkeil’s portfolio
20% Vanguard Total Stock Market ETF (symbol VTI): 28.5% (Tracks a broad index of U.S. companies)
20% Vanguard FTSE All-World ex-U.S. ETF (VEU): 32.3% (Tracks a broad index of stocks from developed and emerging foreign markets)
20% Vanguard Total Bond Market ETF (BND): 7.9%(Tracks a broad index of high-quality U.S. bonds)
10% Vanguard Capital Opportunity (VHCOX): 48.0% (An actively managed fund that likes big growth companies down on their luck)
10% Vanguard Emerging Markets Stocks ETF (VWO): 67.0% (Tracks an index of stocks in developing nations)
10% Templeton Dragon (TDF): 51.4% (Invests in stocks from China and nearby nations)
10% Matthews India (MINDX): 94.6% (Invests in stocks from India)
Total return: 40.3%
William Larkin, a fixed-income manager at Cabot Money Management, in Salem, Mass., excelled with a stock-free portfolio. His package gained 15.5% in 2009, compared with the 6.1% return of the Merrill Lynch U.S. Broad Market index, which tracks high-quality U.S. bonds. Here is his original portfolio and its results for calendar year 2009:
Larkin’s portfolio for 2009
25% iShares Barclays Aggregate Bond ETF (AGG): 5.2% (Tracks a broad index of high-quality U.S. bonds)
25% iShares iBoxx $ Investment Grade Corporate (LQD): 12.1% (Tracks an index of the most liquid, long-term corporate bonds)
10% Fidelity Floating Rate High Income (FFRHX): 28.9% (Invests in floating-rate bank loans that automatically adjust to rising short-term interest rates. It offers an additional inflation hedge.)
10% iShares Barclays MBS Bond (MBB): 5.3% (Tracks a broad index of mortgage-backed securities)
7.5% SPDR DB International Govt. Inflation-Protected Bond (WIP): 18.5% (Invests in an index of non-U.S. inflation-linked bonds)
7.5% PowerShares Emerging Markets Sovereign Debt (PCY): 33.2% (Tracks an index of emerging-markets government debt)
7.5% iShares Barclays TIPS Bond (TIP): 11.4% (Tracks an index of inflation-protected U.S. Treasury securities)
7.5% iShares iBoxx $ High Yield Corporate Bond (HYG): 40.7% (Tracks an index of high-yield bonds)
Total return: 15.5%
Larkin believes that the global economy will improve in 2010 and that the Federal Reserve will start to increase short-term interest rates later this year. As a result, he’s making substantial changes to his income portfolio. In particular, he’s adding investments that he thinks will perform well in an environment of rising inflation. Alas, the changes stretch the concept of a simple portfolio. But starting in 2010, this is his new portfolio:
Larkin’s portfolio for 2010, through February 28
CORE HOLDINGS
15% iShares Barclays 1-3 Year Credit Bond (CSJ): 1.0% (Invests in short-term investment-grade corporate bonds)
15% iShares Barclays Intermediate Credit Bond (CIU): 1.9% (Invests in medium-term investment-grade corporate bonds)
21% iShares Barclays Aggregate Bond (AGG): 1.8% (Tracks the performance of the Barclays Capital U.S. Aggregate Bond index)
10% Pimco Total Return (PTTDX): 2.2% (Invests in fixed-income instruments, such as bonds and debt securities of varying maturities)
ALTERNATIVE FIXED-INCOME
5% Oppenheimer Limited Term Muni A (OPITX): 1.6% (Invests in national investment-grade municipal bonds)
5% SPDR DB International Govt. Inflation-Protected Bond ETF (WIP): -2.0% (Invests in international government inflation-protected bonds that benefit from rising global inflation)
5% iShares Barclays TIPS Bond (TIP): 0.4% (Tracks U.S. government inflation-protected securities)
HIGHER-RISK INCOME
8% Eaton Vance Floating Rate (EABLX): 2.4% (Invests in senior secured bank loans)
8% iShares iBoxx $ High Yield Corporate Bond ETF (HYG): 0.1% (Invests in high-yield corporate bonds)
8% Nuveen High Yield Municipal Bond (NHMAX): 2.6% (Invests in high yield municipal bonds)
Total return for the new portfolio in 2010 through February 28: 1.4%
Total return for Larkin’s portfolios for the 14 months through February 28: 17.2%
The portfolio of our third expert, Larry Swedroe, has roughly equaled the S&P 500’s gain, but it did so with less volatility thanks to a healthy stake in bonds. Swedroe is director of research for St. Louis-based Buckingham Asset Management and author of several useful books, including The Successful Investor Today (St. Martin’s Griffin, $16) and The Only Guide to a Winning Investment Strategy You'll Ever Need (St. Martin’s Press, $26).
Like Malkiel, Swedroe is not altering his portfolio allocations. “The reason is simple,” he says. “I cannot predict which asset classes will do well when, nor can anyone else.” Swedroe does say that given how far stocks have risen over the past year, investors should temper their expectations for future gains -- just as the rout in 2008 should have led investors to expect a good 2009.
Swedroe calls his portfolio “a good starting point for investors, who should then tailor the portfolio to their own unique abilities and willingness and need to take risks.”
Swedroe’s portfolio for the 14-month period through February 28
15% Vanguard Value Index (VIVAX): 19.6% (Tracks an index of undervalued stocks among the largest 750 U.S. companies)
15% Vanguard Small Cap Value Index (VISVX): 32.9% (Tracks an index of stocks of small, undervalued U.S. companies)
13% iShares MSCI EAFE Value Index (EFV): 25.8% (Tracks an index of stocks of large, undervalued foreign companies)
13% iShares MSCI EAFE Small Cap Index (SCZ): 42.6% (Tracks an index of stocks of small overseas companies)
4% Vanguard Emerging Markets Stocks Index (VEIEX): 66.7% (Tracks an index of companies from developing nations)
40% Vanguard Inflation-Protected Securities (VIPSX): 11.2% (Invests in inflation-indexed bonds issued by the U.S. government)
Total Return: 24.1%
Finally, Kiplinger’s entered its own horse in the simple-portfolios race (and by Kiplinger’s, I mean me). Our package gained almost 23% in the 14 months through February 28. But considering that a large portion was in bonds and that the portfolio was much less volatile than the S&P 500, we consider it a solid result.
The portion in the REIT index fund gained a healthy 30%. A few of my colleagues at Kiplinger’s rolled their eyes when I included real estate in my portfolio a year ago, given the drubbing the sector had taken before and during the financial crisis. But the point of crafting a simple portfolio, in my view, is to build a diversified investment plan that you stick with through good times and bad. You don’t try to time the market if you want to keep your investments simple. Now the argument is being made that real estate investment trusts are overvalued (see my colleague Jeff Kosnett’s column, Growing Risk in REITs). But I repeat: You stick with the key elements of a simple portfolio in good times and bad.
That doesn’t mean you can’t tweak your portfolio. I’m making one small change. As of March 1, I’m reducing the allocation to Vanguard 500 Index, which tracks the S&P 500, from 25% to 20% and moving the freed-up cash into Vanguard Emerging Markets Stock Index. Given the fund’s 67% gain over the past 14 months, I don’t expect big gains this year. However, it’s clear that developing nations are growing much faster than the developed world, and over time, that should translate into better stock returns in emerging markets. Here’s how our portfolio performed in the 14 months through February 28.
Kiplinger’s portfolio for the 14-month period through February 28
25% Vanguard 500 Index (VFINX): 25.7% (Tracks Standard & Poor’s 500-stock index)
15% Vanguard Small-Cap Index (NAESX): 38.1% (Tracks an index of small-company U.S. stocks)
20% Vanguard Total International Stock Index (VGTSX): 30.1% (Tracks an index of stocks from developed and emerging nations)
5% Vanguard REIT (VGSIX): 29.5% (Tracks an index of U.S. real estate investment trusts)
25% Vanguard Total Bond Market Index (VBMFX): 7.8% (Tracks a broad index of high-quality U.S. bonds)
10% Vanguard Inflation-Protected Securities (VIPSX): 11.2% (Invests most assets in Treasury inflation-indexed bonds)
Total Return: 22.9%
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