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Lifetime Investing, Part Three—The Global Market Portfolio – The Financial Preserve from Lonier Financial Advisory LLC
Conscientious Financial Planning and Retirement Income Management | 201-741-9528
from Lonier Financial Advisory LLC, Osprey, FL

Lifetime Investing, Part Three—The Global Market Portfolio

Lifetime Investing, Part Three—The Global Market Portfolio

In the last few posts, we have been discussing the investment phases of a lifetime financial plan. In the first we discussed the retirement income phase and in the second, the savings phase.

In this post I will discuss how to create a low-cost, broadly diversified portfolio that is invested in the global economy to reliably produce total market returns, less costs, year in and year out. This approach diversifies away the risk of investing in individual businesses. I will explain it is adjusted to your household balance sheet, so that you do not take on more market risk than your balance sheet affords.

This approach offers a reliable way to invest your savings for long-term growth in the capital markets, with only modest attention needed for periodic rebalancing. It does not involve any stock picking, market timing, charts, specialized funds or exotic analysis. It does not make use of high-priced products or high-cost guidance. No one can predict the markets reliably, so rather than trying to predict winners, we invest in the whole market and reliably harvest market gains.

Before we get started, let me mention once again that although investing is an important component of a lifetime financial plan, it is neither the first nor the most important part of your lifetime financial plan.

  1. Savings comes first—the more you save, the less risk you have to take to meet future goals
  2. For those approaching retirement, a smart Social Security filing strategy can safely add tens and even hundreds of thousands of dollars to your lifetime retirement income—more than you might safely earn by taking on more market risk with your investments. Don’t just file and start collecting as soon as you can. Get this right and you’ll gain significant retirement income.
  3. Smart tax-aware strategies for what kind of accounts to use for your savings and your account withdrawal sequence during retirement can also be more valuable to you over the long term than taking on more market risk stretching for returns

These three items will expand the spending power of your savings and investments more safely and reliably over time than chasing beat-the-market schemes—which can lose you money when you need it most.

The capstone to this careful planning is a broadly diversified global portfolio held for the long term that delivers market gains year after year while avoiding the common costly investment mistakes of paying high fees, trying to pick winning stocks, and trying to time the market.

Setting Up The Portfolio
The global market portfolio I use is made up of two sub-portfolios that I vary in size relative to each other based on your household balance sheet. One is made up of low-cost bond ETF index funds and the other of low-cost stock ETF index funds.

The bond portfolio is based on a broad total US market fund (BND) augmented by short and medium duration TIPS (VTIP, VIPSX), short and medium duration high-yield (HYS, HYG), intermediate investment grade corporate bonds (VCIT, BIV), and short term bonds (BSV). For taxable accounts, municipal bonds (VWITX) are subbed for a slice of BND.

(*VIPSX and VWITX are low-cost Vanguard index-like mutual funds. They aren’t true index funds, since there are technical issues indexing the TIPS and muni markets, but VWITX has over 4,000 holdings, more than most muni ETF funds.)

The stock portfolio is based on a broad total US market fund (VTI), along with a US small cap fund (VB), Europe (VGK), Pacific (EPP), Japan (DXJ), international small cap (VSS, DLS), international emerging market (EEMV, DGS), domestic real estate (VNQ), and commodities futures (DBC).

The bond portfolio provides income and ballast to the riskier holdings in the stock portfolio. Most of the risk in the portfolio comes from stocks, though bonds are subject to both credit and interest rate risk.

How Does Indexing Work?
Both sub-portfolios are broadly diversified and roughly representative of the global capital markets. How diversified? There are over 15,700 bonds in the nine bond funds, totaling $252 billion in assets, and over 10,900 stocks in the 10 stock funds, from over 40 countries, totaling over $353 billion in assets. These holdings are not individually picked—they are indexed to represent the broad global capital markets, weighted mostly by their size in those markets. In this way, the portfolio reliably produces the same returns as the global markets, less the cost of investing (the fund expense ratio and transaction costs).

The portfolio uses mostly Vanguard funds, which operate at low-cost, and, when custodied at Vanguard, trade without charge, which makes buying and rebalancing essentially free.

The total cost of this broadly diversified global portfolio is about .30% per year, a fraction of the cost of the typical mutual fund that charges 1.25%/yr in a 401(k) or that is offered by one of the name-brand banks.

The lower the costs, the more of your invested capital that keeps earning and compounding over time—which can make ten and hundreds of thousands of dollars difference over a lifetime of saving and investing. Consider that a 1% overall expense ratio is 20% of the expected 5% return of global portfolio! That’s a deep cut of your returns! Don’t give that away!

Individualizing the Global Portfolio
I use this portfolio as a baseline for everyone. The most important personalized variable is the overall ratio of bonds to stocks based on your household balance sheet—vital to ensuring that you are not overexposed to market risk.

For someone nearing retirement whose balance sheet does not show a high coverage ratio of savings to expenses, the ratio of bonds to stocks will be higher than for someone who has more cushion—and therefore more risk capacity. If you have more cushion, then you can safely expose more of your capital to market risk in the equity markets for long term growth. If you are younger and your income is variable or risky, the human capital on your balance sheet may be lower than that of someone with a very secure job with a pension—and so your balance sheet will show you should take less market risk even though you are younger.

As you can see from the diagrams below, the weight of each fund within the two sub-portfolios stays the same as the sub-portfolios scale up or down to align with your household balance sheet, so the global returns within each sub-portfolio remain proportional even as we adjust your exposure to market risk. Simply put, the greater the overall percentage of stocks, the higher risk, and the larger cushion you need on your balance sheet to safely invest at that level.







In this way, the portfolio is based on your household financial situation and not on rules of the thumb or other arbitrary formulas like your age or what a portfolio manager thinks you should have based on a target date portfolio. Your balance sheet might indicate more or less cushion than your age or planned retirement date, and so those approaches might be inappropriate for you, with too little or too much risk.

Incidentally, I recently presented my method of using the household balance sheet to set portfolio allocation at the Retirement Income Industry Association boot camp in Salem, MA, and will be presenting it to the fall RIIA conference at DFA headquarters in Austin in October. You can read about the Salem presentation in an article by Wade Pfau.

In the next post, I’ll cover in more detail how to use your household balance sheet to set the amount of market risk that is appropriate to your financial situation.

In the meantime, if you have any questions or comments, please let me know!
–Mike Lonier, RMA℠

Disclosure: The author and clients of LFA LLC invest in the funds mentioned in this article (Yes, we eat our own dogfood!). This post is intended to be informational and is not personal investment advice and does not provide personal recommendations to buy, sell, or hold specific securities. Investment advice requires the analysis of individual circumstance and personal goals, which vary considerably from person to person.


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