My asset allocation

May 8, 2018 · 1280 words · 7 minutes read Investing

In a previous post, I explained some of the basic principles of asset allocation. Here, I am going to present the concrete selection of ETFs that I have started building up since February of this year. First I am going to go over the various allocation classes that are in my portfolio. After that, I will show which ETFs I selected for each class. This latter part is especially interesting for other Belgian investors.

My portfolio

After reading a lot on the matter (not that I am done learning), I settled on the portfolio below.

Type of investment Allocation
Government bonds 15%
MSCI World 50%
Small cap 15%
Emerging markets 10%
REIT 10%

Government bonds

Bonds are a loan that you make to an institution such a government or a corporation. As the lender, you make a return through the interest.

How much in bonds, how much in stocks?

Between stocks and bonds, bonds are the least risky. This means that it is less volatile but it also yields less potential returns. One of the most important splits in a portfolio is therefore how much you allocate in bonds and how much you allocate in stocks. There are several guidelines on this.

For instance, Benjamin Graham (one of Warren Buffett’s mentors) had the following to say about it:

We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of 75% to 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.

John Bogle recommends to invest roughly your age in bonds. This means that if you’re 35 years old, he recommends a portfolio of 35% bonds and 65% stocks.

I find both of these guidelines to be quite conservative. In the end, it is all about how much you risk you are willing to take and how long your time horizon is. If you plan on retiring in 5 years, you simply can’t afford to lose half your money in the case a 2008 scenario repeats. Then, it is wise to invest the majority of your portfolio in bonds.

In my case, being 28 years old, I estimate having about 40 years of saving ahead of me. If there’s a big economic downturn in a few years, I’ll have plenty of time to recover from those losses. For this reason, I chose for a 15%-85% split. This is pretty risky according to these guidelines but this is a risk which I can live with.

Government bonds over corporate bonds

Furthermore, I chose not to include corporate bonds and went for only governments bonds instead. Since the bonds part of a portfolio is the safe part, I’d rather not take risks through corporate bonds.

MSCI World

The MSCI World is an index that consists of 1,654 stocks from companies from the developed world. It is rougly a mix of the biggest companies from the US, Europe, Japan and other developed nations (this brochure contains more information).

I like to see it as an investment in the world economy because it represents the largest companies from the biggest economies in the world. That’s why it takes the biggest portion of my portoflio at 50%.

Small cap

A small cap fund is a fund that invests in smaller companies but that are still publicly traded. In “A crash course on asset allocation” I talked about how important it is to pick securities in your portfolio that are not correlated or negatively correlated. This is exactly the utility of a small cap fund in a portfolio. History shows that there are periods where the largest companies suffer but smaller companies flourish, and vice versa. Hence a small cap fund will not be completely correlated with a total market index such as MSCI World.

A small cap index is definitely more volatile than the MSCI World index, which warrants a lower allocation of 15%.

Emerging markets

Emerging markets are countries such as China, South Korea, India and Brazil. A portion invested in those markets makes sense for the same reason why small cap stocks are included: diversification. After all, the economies in these countries don’t always follow the trend of the world economy.

REIT

REIT, or real-estate investment trusts, are funds that invest in the real-estate market. This market moves fairly distinctly from the bond or stock market. Therefore, they’re great for diversification.

What’s not in my portfolio

The portfolio is diversified over:

  • geographical areas: the MSCI World index covers the 23 biggest economies in the world and the emerging markets are also represented.
  • asset classes: the portfolio represents bonds, stocks and the real-estate market.
  • market cap: the small caps fund makes sure that smaller companies are also included.

However, it does not have:

  • individual stocks: I think that individual stocks are too risky for the purpose of my portfolio, i.e. to save for the long-term. I do own a couple of individual stocks but I put those in a “play-portfolio”.
  • sector-specific funds: there are ETFs that track specific industries, for instance tech, automotive, AI,… However, I deem these too risky too. In the end, all the sectors are already represented in the various funds that I own.
  • commodities: I don’t understand these markets enough and chose not to include them. However, I do believe they can have a role in your portfolio.

The corresponding ETFs

So now we know what allocation classes are in my portfolio. We still have to pick specific ETFs for each class. This is where the country to live in matters as some funds are only available to US investors and others are targeted for European investors.

Let’s recap the criteria for a Belgian investor:

  • always pick accumulating ETFs
  • invest in funds domiciled in Ireland or Luxembourg

Finding the right ETFs that match these criteria and that also have a low total expense ratio was quite a long process. It involved lots of comparisons on justETF. But in the end I managed to find a mix that I’m satifisfied with:

Type ETF TER
Government bonds Lyxor EuroMTS Highest Rated Macro-Weighted Government Bond 0.17%
MSCI World iShares Core MSCI World 0.20%
Small cap BNP Paribas Easy MSCI Europe Small Caps ex Controversial Weapons 0.25%
Emerging markets Xtrackers MSCI Emerging Markets 0.20%
REIT Amundi ETF FTSE EPRA Europe Real Estate 0.35%

All these ETFs can be bought through Lynx and probably the other brokers in Europe too.

My plan for investing

On February, I invested part of my savings according to this allocation. Currently, I am planning to rebalance and invest more of my savings at the end of the year. The reason I don’t do this more frequently is because there are transaction costs involved with every trade. However, I might change my mind and do an intermediate round towards the end of June.

For the longer term, I want to stick with this asset allocation for a long period of time. At some point, I will want to increase the portion of bonds but I feel that I have some years ahead before that moment comes.

What about the results?

I will post the first quarterly report here in July. I’m looking forward to sharing this with you as I’m extremely curious myself how my portfolio actually performs in practice.

In any case, the whole process in getting to this portfolio has been very informative and I thoroughly enjoyed all the reading I did, as well as figuring things out. I embarked on a learning journey that I hope not to abort soon.