A Robust Wealth-building Machine: How to Allocate and Optimize your Retirement Portfolio for Maximum Return
The building blocks of my investment portfolio
Previously, I lucidly outlined the differences and similarities between index funds, exchange-traded funds and stocks. I am a big advocate of passive investing using index funds and exchange-traded funds; this is what legendary investor Warren Buffet recommends for the average Joe and Jane. With this powerful investment portfolio, I won't be an average Joe much longer. Neither will you. Here's my simple 7-fund retirement portfolio pie chart.
A robust 7-fund allocation portfolio
Diversification, low-cost and simplicity are essential to investing. Diversification is the simple process of putting your money in different asset classes or sectors to minimize financial loss. Using a combination of low-cost index funds and exchange-traded funds, my investment portfolio is composed of equities and short-term/fixed investments (see image below).
Here's a breakdown of the seven funds and their respective YTD earnings as of 5/19/2019.
- A U.S. large cap S&P 500 index fund (50%); YTD +14.98%
- A U.S. mid cap index fund (15%); YTD +16.53%
- A U.S. small cap index fund (5%); YTD +14.50%
- An international ETF (12%); YTD +10.44%
- A short-term bond ETF (10%); YTD +2.54%
- A long-term bond ETF (5%); YTD +4.05%
- A real-estate ETF (3%); YTD +18.61%
For a discussion on the different types of cap funds (cap = capitalization) referenced below, click here. Your allocation percentages may be different, and will be dependent upon your risk profile, age, and tolerance, among other things. So, what's the idea behind putting a whopping 50% into a single large cap fund?
The case for a U.S. large cap S&P 500 index fund
The S&P 500 is a basket of the 500 largest American companies. Large caps are companies with market value of $10 billion or more. A large cap fund should occupy the bulk of your portfolio, especially if you are decades away from retirement. One might think that allocating 50% into a single fund is pretty excessive. I am many years away from [hopeful] retirement. By investing in a S&P 500 fund, I, like Warren Buffet, am betting on the continued success of American companies. Never bet against America!
The case for a U.S. mid cap index fund
A mid cap fund gives you exposure to companies with a market value between $2 billion and $10 billion dollars. Mid cap companies, including Tesla, are not part of the S&P 500. For the purpose of diversification, you need to include them in your investment portfolio. I have allocated 15% into a fund composed of over 3000 mid cap stocks!
The case for a U.S. small cap index fund.
Small cap funds are companies with market value between $50 million and $2 billion dollars. Never underestimate the power of the little guy. When the big guys (large and mid caps) fall, the little guys may come to your portfolio rescue. An allocation of 5% into a small cap index fund, composed of over 2000 small companies stocks, is just a wise move.
The case for an international ETF
The stock market is more than the U.S. economy. It is essential that your investment portfolio include foreign stocks. If U.S. stocks experience a bear market, your foreign investments can help provide financial cushion to your portfolio, while your U.S. equities recover. A 15% allocation into a single foreign ETF, composed of large, mid and small foreign companies, is all my portfolio needed.
The case for a short-term bond ETF
Although investing in index funds and ETFs reduces risks, you can still lose money. Therefore, it is prudent that your investment portfolio include bond funds. Here's more information on bond funds. Bonds give your portfolio stability, as they are safe investments. I allocate 10% into a short-term U.S. Treasury bond ETF. I trust the U.S. Treasury will give me my money back, just like it always does with China!
The case for a long-term bond ETF
I allocate 5% into a long-term bond ETF for the reasons outlined in my short-term bond ETF above. There are circumstances where bonds may not be right for your portfolio.
The case for a real estate ETF
The S&P 500 index includes companies from virtually all U.S. economic sectors. I debated really hard whether I needed a separate real estate fund, given that my large cap S&P 500 fund already provides me with real estate exposure. This index includes a little more than 30 muti-sector real estate stocks. As someone who likes the idea of being a real estate investor without buying physical properties, I decided to allocate 3% into a real estate ETF. Composed of roughly 200 stocks, this ETF provides access to approximately 150 real estate stocks not included in the S&P 500.
At first glance, one would think that this investment portfolio is expensive. It's very cheap to establish and maintain. The total or combined expense ratio of the funds in this portfolio is nothing short of extraordinary.
Investing should be cheap.
Brokerage and other investment fees will devour your returns, if you are not careful. A brokerage fee is a fee charged by an investment broker each time an investor buys or sells a security (stock, exchange-traded funds, etc.). If you are actively buying and selling securities, you can see how such fees can diminish your returns. Besides brokerage fees, expense ratio fees are investing fees to be mindful of. The expense ratio is investing fees a mutual fund or ETF shareholder pays to help cover the fund's expenses. My entire investment portfolio's expense ratio is a paltry 0.42% (see below). If you ask me, that's insanely nuts! Let me put this expense ratio in perspective.
With an expense ratio of 0.42%, I can expect to pay around $42 annually--emphasized $42 annually--for every $10,000 in the account. What a cheap way to get rich!
The bottom line
Cash is trash. Investing offers you the best opportunity to build wealth and save for retirement. My simple 7-fund retirement portfolio leverages the power of passive index investing to help you optimize your retirement portfolio for maximum return. I think this robust investment portfolio can put you on a path to a brighter financial future. For the exact names and ticker symbols of the funds in this portfolio, please subscribe below. After subscribing, I will divulge the identity of those funds, along with an Excel spreadsheet where you can plug in your own numbers.
If you prefer to leave investing to the pros, here are a few investment brokers and robo-advisors I think can provide you with an investment portfolio comparable to the one I just outlined.
- Wealthsimple. This robo-advisor will help you diversify your investment portfolio across the entire market, using low cost ETFs. They even show you how much your money can grow with their simple-to-use investment simulation calculator. Start investing with Wealthsimple today.
- Acorns. This robo-advisor allows individuals to become investors with the simple use of an app. Check out these Acorns reviews or invest with Acorns.
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