Building a Balanced, Low-Cost Portfolio

I recently wrote articles directed to prudent investors regarding minimizing fees and expenses on their investment portfolios while utilizing asset allocation and rebalancing to sub-asset class levels. An explanation of how to build a “deadbeat portfolio” is now in order.

To start, I analyzed the Vanguard target retirement date funds and their publicly available recipes (simple mixes of four to five index funds). Vanguard created their family of low-cost target retirement date funds primarily for investor convenience. The funds are completely diversified investment portfolios. Simply pick the fund that has the date closest to when you plan to retire and add as much as you comfortably can on an ongoing basis. Be sure to stay within annual contribution limits if utilizing an IRA or other retirement registration. The funds automatically rebalance and get more conservative (selling stocks and buying bonds) as they approach their target dates. (For more, see: Cut Your Investment Fees to Be a Wall Street Deadbeat.)

The Equity (Stock) Side of the Equation

Vanguard builds the equity portion of their target retirement date funds with a 60% domestic and 40% foreign stock allocation. I utilized a look-through analysis tool to design the domestic stock allocation to be similar in structure and style to that of the Dow Jones U.S. Total Market Index. I also analyzed the Vanguard Total International Stock ETF (VXUS) recipe to determine and split out the emerging markets aspect of the international equity portion of the portfolio. (For related reading from this author, see: Why Asset Allocation Is Important in Your Portfolio.)

A Deadbeat Equity (Stock) Portfolio Example

  • 22%  Vanguard mega cap value ETF (MGV)
  • 22%  Vanguard mega cap growth ETF (MGK)
  • 5%  Vanguard mid-cap value ETF (VOE)
  • 5%  Vanguard mid-cap growth ETF (VOT)
  • 6%  Vanguard small-cap ETF (VB)
  • 33%  Vanguard FTSE developed markets ETF (VEA)
  • 7%  Vanguard FTSE emerging markets ETF (VWO)

The Fixed Income (Bond) Side of the equation

Vanguard builds the fixed income portion of their target retirement date funds with a mix of domestic bonds, international bonds and inflation-protected securities. The ratios between the sub-asset classes differ based on the amount of equity in the portfolio and phases out the inflation-protected securities when stocks get to a weighting of about 65% or more of the portfolio. Inflation-protected securities are phased out at the 65% level of equity weighting because the percentage of stocks alone provides enough inflation protection without the need for an additional position in inflation-protected securities. The ratio of domestic bonds to international bonds appears to be somewhere around two-to-one.

A Deadbeat Fixed Income (Bond) Portfolio Example

  • 61%  Vanguard total bond market ETF (BND)*
  • 26%  Vanguard total international bond ETF (BNDX)
  • 13%  Vanguard short-term inflation-protected securities ETF (VTIP)

*As I wrote in a previous article Investment Grade Bonds and Your Portfolio, Vanguard total bond market ETF (BND) could be replaced with certificates of deposit (CDs) or an investment grade bond ladder. When purchasing new-issue CDs in a Vanguard brokerage account, Vanguard requires a minimum purchase of $10,000 per issue to avoid commission charges.

To determine an asset allocation of stocks, bonds and cash for your portfolio, you might visit the internet and search for an investment profile questionnaire. There are many free questionnaires on the internet that can be utilized to determine an appropriate asset allocation. Once you are pointed to an asset allocation, be sure to review its historical performance and be comfortable with the risk and volatility associated with it. 

A balanced portfolio evenly split between the deadbeat equity portfolio example and the deadbeat fixed income portfolio example would have an internal expense ratio below one-tenth of a percent (.1%) and below the internal expense ratios of Vanguard target retirement date funds themselves. Breaking the portfolio down into more sub-asset classes allows greater opportunity for harvesting off and fertilizing of the trees in the orchard/portfolio (For related reading, see: Sub-Asset Classes Are Crucial for Your Asset Allocation).

As with any portfolio of investments, it is important to rebalance the portfolio back to its original mix occasionally. At a minimum, rebalancing annually or when an asset class deviates by 5% or more from its original allocation should be considered. Building and rebalancing these portfolio examples in a Vanguard brokerage account would allow for commission-free trades of Vanguard ETFs.