Six Versus Five SIB
03/24/2011 0 comments
Life moves quickly. Already this year we have seen troubles in Egypt being supplanted by Tunisia and Bahrain. This was swept into the background by the triple disasters in Japan and now Libya grabs the headlines. All of this twists and turns markets all the while, we may worry about how that impacts our retirement as well as being caught up in the human tragedy.
One of the most glaring holes in our education system is retirement investing. As a result, we feel afraid and powerless and look to “big brother” to help out. Be aware that some of the biggest pension schemes in the country are failing with terrible returns. Many states are in real trouble because of the pension liabilities so they aren’t doing any better. As inflation bites, it is unlikely that these pension schemes will keep up. In any case, increasingly they are a thing of the past. 401K plans have moved from being an adjunct to a pension plan to being the mainstay of retirement income. In a study of over 800 mainly retirement plans, we noted that the majority of plans supported only three asset classes which is going to have a significant impact on the potential returns for the participant.
| Asset Classes | Number of plans |
| Three | 59 |
| Four | 23 |
| Five | 14 |
| Six | 4 |
Sadly, only 4% of the plans we reviewed had the six asset classes to build the sort of portfolios necessary to optimize returns and minimize risk.
In a previous article we found reviewed historical simulations from a five asset class plan would, over a decade, put 75% more money in your pocket compared to a three asset plan which is the staple of most 401(K) plans. In this article, we are going to add commodities as another class to provide diversification protection.
We use a simple benchmark vehicle -- SIB -- simpler is better to show the potential difference in returns between the portfolios with different numbers of asset classes.
Each of the SIBs are built from one ETF per asset class. The ETFs we selected for these portfolios are as follows:
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE BLEND | VTI | Vanguard Total Stock Market ETF |
| Foreign Large Blend | VEU | Vanguard FTSE All-World ex-US ETF |
| DIVERSIFIED EMERGING MKTS | VWO | Vanguard Emerging Markets Stock ETF |
| REAL ESTATE | VNQ | Vanguard REIT Index ETF |
| COMMODITIES BROAD BASKET | DBC | PowerShares DB Commodity Idx Trking Fund |
| Intermediate-Term Bond | BND | Vanguard Total Bond Market ETF |
So the three asset SIB has (VTI), (VEU) and (BND). The four asset SIB adds emerging markets (VWO). The five asset SIB adds Real Estate (VNQ). The six asset SIB adds commodities (DBC). Note that these ETFs were chosen arbitrarily. If you want to see a range of alternatives and their relative performance, MyPlanIQ maintains updated information on major ETFs in most asset classes.
Commodities can be volatile and some may have trepidation in owning this type of asset. ETF's which are broadly diversified reduce the volatility and don't rely on fund managers who can be hit or miss. In the coming years, commodities will be important and have already shown their value as inflation is an issue in emerging markets and will shortly start to arise more locally.
If we compare the historical returns between the five and six asset SIBs, we can see the benefit of adding the extra asset class.
Performance chart (as of Mar 2, 2011)
Performance table (as of Mar 2, 2011)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Six Core Asset ETF Benchmark Tactical Asset Allocation Moderate | 16% | 129% | 9% | 74% | 13% | 88% |
| Six Core Asset ETF Benchmark Strategic Asset Allocation Moderate | 17% | 152% | 4% | 19% | 7% | 32% |
| Five Core Asset ETF Benchmark Tactical Asset Allocation Moderate | 12% | 104% | 7% | 65% | 10% | 69% |
| Five Core Asset ETF Benchmark Strategic Asset Allocation Moderate | 16% | 139% | 4% | 16% | 6% | 22% |
If we ignore the short term difference -- which are not insignificant -- and look at the five year returns we see a difference between five and six assets.. Note that the difference in returns between three and six asset SIB, over a decade -- puts more than twice the amount of money in your nestegg.
We also note that after starting the year very strongly, US Equities gave back much of their gains over the past month -- something that a portfolio with access to commodities and real estate mitigated to a large degree.
You may not have all the asset classes in your current 401K plan -- but if you have an IRA or the chance to rollover an old 401K into an IRA and assemble a six asset portfolio, you will thank yourself when you retire.
Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.
Exchange Symbols:(NYSE,VTI),(NYSE, ,SPY),(NYSE,VEU),(NYSE,EFA),(NYSE,VWO),(NYSE,EEM),(NYSE,VMQ),(NYSE,IYR),(NYSE,BND),(NYSE,AGG),(NYSE,IEI),(NYSE,SHY),(NYSE,TIP),(NYSE,EFV),(NYSE,IWM),(NYSE,IWN),(NYSE,IWW),
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