"Ultimate" isn't a term I toss around lightly. But in this case it fits. The investment portfolio I'm about to describe is, in my view, the absolute best way to invest in the global stock markets for long-term growth.
This bold assertion is based not only on my own 50 years of experience working with thousands of investors but also on the very best academic research of which I am aware.
In a nutshell, here it is: The portfolio starts with the Standard & Poor’s 500 Index /zigman2/quotes/210599714/realtime SPX -2.27% , then adds equal portions of nine other very carefully selected U.S. and international asset classes, each one carefully chosen to be an excellent long-term vehicle for diversifying from the S&P 500.
The result of all this, when it's done properly, is a low-cost portfolio with massive diversification that will take advantage of market opportunities wherever they are — at almost no additional risk above that of the S&P 500.
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When I describe this portfolio I like to roll it out in steps, instead of all at once. That way, investors can see how it goes together. (Perhaps this is like showing somebody how a savory stew is concocted, one ingredient at a time.)
In this case, the base ingredient is the S&P 500, which is a pretty decent investment by itself. For the past 45 calendar years, from 1970 through 2014, the S&P 500 compounded at 9.5%. An initial investment of $100,000 would have grown to $5.84 million. Data sourced for this report comes from Dimensional Fund Advisors.
For the sake of our discussion, think of this as Portfolio 1. Can we make significant improvements, step by step, without increasing volatility? Yes.
The first asset class I add is U.S. large-cap value, made up of large-cap stocks that are regarded as relatively underpriced, hence the term “value.”
(The links above, and others below, are to my recent articles focusing on each asset class.)
Because this portfolio will eventually wind up with 10 asset classes of equal proportions, I'll construct what I call Portfolio 2 with the combination of 90% in the S&P 500 and 10% in large-cap value.
This is a pretty small change, since 90% of the portfolio remains the same. And yet, assuming annual rebalancing, Portfolio 2's 9.9% compound growth in those 45 years was enough to grow $100,000 to $6.95 million.
In dollars, that's a 19% increase that resulted from changing only one-tenth of the investments. Right away, I know something important is happening.
The next step, Portfolio 3, adds 10% in U.S. small-cap blend stocks and decreases the weight of the S&P 500 to 80%. Small-cap stocks, both in the U.S. and internationally, have a long history of higher returns than the S&P 500, partly because they obviously have more room to grow.
This change boosts the compound return to 10.1%; an initial investment, again with annual rebalancing, would have grown to $7.44 million.
Moving one further step, we add 10% in U.S. small-cap value stocks, reducing the influence of the S&P 500 to 70%. Small-cap value stocks historically have been the most productive of all major U.S. asset classes.
Their addition creates Portfolio 4, with compound performance of 10.5%, enough to turn that hypothetical $100,000 investment into $8.95 million.
Compared with Portfolio 1, that's a dollar increase of 53%, while still leaving more than two-thirds of the portfolio in the S&P 500. To my mind, that's a mighty fine result.
The next step is Portfolio 5, in which we take away another 10% of the S&P and invest that 10% in U.S. REITs funds. Results: a compound return of 10.6% and an ending cash value of $9.44 million.
At this juncture, I want to make two important points.