Outside the Box: These fund combinations can give you a huge boost over the S&P 500

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Since the mid-1990s, I have been teaching investors that the very best way to diversify among equities is through a 10-fund portfolio that I call the Ultimate Buy and Hold Strategy.

However, as many people over the years have reminded me, 10 index funds or ETFs are too much to deal with.

I’m pleased to say I have found a four-fund strategy that, over the past half-century, would have provided essentially the same return as the 10-fund version — about the same level of risk.

That’s one of three all-star equity portfolios I’ll describe in this article. Each one is derived from The Ultimate Buy and Hold Strategy that I recently described.

Each of these portfolios is made up of all-star asset classes (chosen by academic researchers) and all-star ETFs (chosen by Chris Pedersen, Director of Research for the Merriman Financial Education Foundation).

The majority of each of these portfolios — in one case all of it — is made up of asset classes that over the past 90 years have significantly outperformed the S&P 500 index SPX, -0.24%.

I still think the 10-fund version, with its massive diversification in both U.S. and international asset classes, is the very best equity portfolio, and it’s the basis for most of my own investments.

None of these portfolios is perfect, of course. For example, there will be periods when the S&P 500 alone outperforms the other major asset classes.

But in studying returns going back 51 years, we found that 10 funds weren’t necessary. Four asset classes would have done the trick: U.S. large-cap blend stocks (like the S&P 500), U.S. small-cap value stocks, international large-cap value stocks, and international small-cap blend stocks.

That is the world-wide four-fund combo. With equal weights in those four asset classes, this portfolio provides what long-term equity investors need most: growth and value, large and small, U.S. and international.

Worldwide four-fund combo, 1970-2020

Asset class Compound return
U.S. large blend 10.7%
U.S. small-cap value 13.5%
International large value 9.4%
International small blend 13.3%
Portfolio 12.4%
Initial $10,000 grows to $3,852,195

This portfolio’s compound return (based on annual rebalancing), is identical to the 12.4% compound return of the 10-fund Ultimate Buy and Hold Strategy.

What’s good about this portfolio: Nearly everything, with robust diversification in a simple package that’s easy to manage.

Who this is for: Patient long-term investors who are willing to hold and periodically rebalance four funds.

Where this portfolio is weak: This doesn’t cover every available asset class. Sometimes U.S. small-blend stocks will do better than international ones, for example, and vice versa. Some investors aren’t comfortable owning international funds.

Next, the U.S. four-fund combo, which I’ve written about in the past.

This is very similar to the world-wide portfolio I just described. The difference is that this one uses U.S. funds exclusively.

U.S. four-fund combo, 1970-2020

Asset class Compound return
U.S. large blend 10.7%
U.S. large-cap value 12.1%
U.S. small-cap blend 11.4%
U.S. small-cap value 13.5%
Portfolio 12.2%
Initial $10,000 grows to $3,508,000

What’s good about this portfolio: Nearly everything, with robust diversification in a simple package that avoids international funds and is easy to manage.

Who this is for: Patient long-term investors uncomfortable investing internationally.

Where this portfolio is weak: This exclusive U.S. mix will lag in periods when international stocks outperform U.S. stocks.

For more adventurous investors, the world-wide value portfolio offers a five-fund combination with historically higher long-term returns.

This contains U.S. and international value funds, both large-cap and small-cap, plus a slice of emerging markets.

Worldwide value portfolio, 1970-2020

Asset class Compound return
U.S. large-cap value 12.1%
U.S. small-cap value 13.5%
International large-cap value 9.4%
International small-cap value 13.4%
Emerging markets 12.9%
Portfolio 13.0%
Initial $10,000 grows to $5,120,883

What’s good about this portfolio: The strict value orientation provides the highest performance of all, by a significant margin. Diversification includes large and small, U.S. and international.

Who this is for: Long-term investors who can accept additional risk and tolerate performance that’s usually different from the S&P 500 and other popular indexes.

Where this portfolio is weak: Of the three portfolios I’m describing here, this is the least predictable, hence slightly more risky. In a serious market decline, value funds can decline much more than blend funds and growth funds.

Here’s a question I’ve been asked: If these portfolios equaled or outperformed the 10-fund Ultimate Buy and Hold Strategy, why not abandon the 10-fund version altogether?

Here’s my answer, which I know won’t convince everybody. The Ultimate Buy and Hold Strategy’s massive diversification goes beyond any of these other combinations.

With 10 funds, you will always own whatever major asset class is performing the best. With only four or five funds, you might miss out on that.

Before you implement any of these portfolios, you should be aware of the statistical risks.

Annualized standard deviations

Standard & Poor’s 500 Index 16.9%
Ultimate Buy and Hold Strategy 18.5%
U.S. Four-Fund Combo 18.5%
Worldwide Four-Fund Combo 18.9%
Worldwide Value Portfolio 19.3%

You can build these portfolios with exchange-traded funds available through any brokerage. Here are our specific recommendations:

Asset class Recommended ETF (ticker)
U.S. large-cap blend AVUS
U.S. large-cap value RPV
U.S. small-cap blend IJR
U.S. small-cap value AVUV
International large-cap value EFV
International small-cap blend FNDC

Creative investors can use this information to build their own combinations.

For example, I know a woman whose IRA is a variation on the world-wide four-fund combo. Half of her equity investments are in a fund that generally follows the S&P 500. Since U.S. large-cap blend stocks are already amply represented, she divided the rest of her equity holdings equally among U.S. small-cap value, international large-cap value and international small-cap blend.

Any way you do it, adding just a few of these all-star asset classes to the S&P 500 can result in a huge long-term improvement.

For more on this whole topic, check out my podcast, How to simplify the Ultimate Buy and Hold and get higher returns.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.

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