Portfolio Construction
My Base Portfolios
First let’s be upfront. There are lots of ways to manage money. Some are potentially better than others. There are also a lot of wrong ways. Most of the time failures evolve around becoming too greedy, too fearful, or a lack of patience.
Warren Buffett said many years ago – “When the market becomes expensive zip up your wallet and go away for a couple of years”. Not days or months!
Additionally, many lack the true knowledge of where long-term returns come from and their associated fundamentals. Information is benign if we can’t analyze and act on it in a reasonable time frame. A set of tools are needed that you trust and are based on solid academic and historical foundations. They must be applied consistently and be absent of behavioral biases typically found in investors.
We chose these three portfolios as a foundation:
There are three distinct categories of risk:
Conservative (Less risky)
Moderate (More risky)
Aggressive (Most risky)
With just three options, people can more easily understand the risk-return tradeoffs of each portfolio, leading to better-informed decisions and increased likelihood of sticking to a chosen strategy during market volatility.
We understand that all people want more return but at what price? After decades in the business, we have never met an investor that said they didn’t mind risk after a series of high returns. We all like risk until it shows up! Let’s see the price that must be paid in order to receive that higher return.
1. Key metrics: $100,000 Portfolios (2014-2024)
This table shows the historical returns, risk (volatility), and value-at-risk for each portfolio from 2014 to 2024. Every leg up to next the riskier portfolio comes in at an increased volatility and a potential higher loss during extreme market stress (value at risk). In more layman’s terms, value at risk can be interpreted as 5% of the time the portfolio would expect losses to be greater than $9,800 in a conservative portfolio. This is the price that must be paid in order to achieve the higher return.
2. Why only 3 assets?
Using these three asset provides the portfolio with exposure to U.S. financial markets (VOO), U.S. Bonds (AGG), and “Cash” (BIL). As a portfolio it offers diversifying attributes and low correlations.
When markets become more volatile, assets tend to move together and can lack properties of risk reduction. Cash and treasuries have low correlation shielding the portfolio from large drawdowns. In fact, treasuries often have negative correlations in very turbulent environments. This provides the portfolio with slight positive returns on the AGG and BIL while risky assets, VOO, are declining.
3. Whats so special about VOO, AGG, and BIL?
VOO
Is the Vanguard proxy for the S&P 500. The S&P 500 captures a large portion of the total U.S investable equities market. In addition, it is published daily and is easily tradable with no issues regarding liquidity. This is a low-cost exchange traded fund (ETF).
AGG
The iShares proxy for the U.S. investment grade bond market. It encompasses a medium maturity mix of Treasuries, Corporate bonds and Government Agency securities. It holds over 11,000 bonds and has a market cap of $120 billion. This is a low-cost ETF.
BIL
The State Street proxy for the 1-to-3-month treasury bill and acts as a safe haven for cash like instruments. The market cap is $34 billion and is highly liquid.
Conclusion
This three-portfolio approach, utilizing VOO, AGG, and BIL, represents an optimal balance of simplicity and sophistication in portfolio management. The three distinct risk categories - Conservative, Moderate, and Aggressive - provide clear risk-return tradeoffs while gaining comprehensive market exposure through highly liquid, low-cost ETFs. While there are many more aspects we could explore regarding portfolio construction, this straightforward combination of clarity, efficiency, and effective risk management demonstrates a sound framework for long-term portfolio management.
For any questions please email: j@anti-advisor.com