investing

Equally weighted asset allocation strategy

Investing pie chart
Highlights
  • You can construct a portfolio with ETFs that target specific slices of the market.
  • By picking funds from different asset classes in equal weights, you can reduce risk.
  • The idea of spreading wealth evenly goes back to the Babylonian Talmud.

Investment strategists have been telling us for years that asset allocation -- owning several asset classes, such as stocks, bonds and real estate -- is the way to successfully manage risk and return in pursuit of financial goals.

It's never been easier to diversify, thanks to the growing list of low-cost exchange-traded funds, or ETFs, that target specific pieces of the world's markets. But that still leaves the critical decisions of picking funds and determining how to manage the mix.

It's easy to be confused by all the products and the free flow of advice. How can you maintain strategic perspective in a world that's becoming more complex by the day? You can create a simple benchmark: an equally weighted portfolio of all the major asset classes. For example, the investment landscape can be carved up into 10 primary markets. In that case, equally weighting simply means each piece represents 10 percent of the total investment pie.

Why an equal-weight benchmark? Because it's truly passive. By contrast, conventional cap-weighted benchmarking holds assets in proportion to their relative values. The underlying assumption: The market's always "right." If the market value of stocks is twice that of bonds, stocks receive twice the weight in a portfolio.

By the way, don't confuse the equal weighting of an asset allocation strategy with equal weightings of individual investments within a fund. You can buy ETFs that are equally weighted or market-capitalization weighted -- or both -- to implement an equally weighted asset allocation plan, for instance.

This benchmark, which can be built with a core set of ETFs, requires no investment skill. And it tends to earn average to above-average returns relative to most of the competing strategies. What's the catch? You'll have to crunch the numbers yourself, but that's easily done by computing the average return for 10 broadly defined ETFs that represent each asset class. The table on the next page provides some fund examples.

Equally weighting a broad spectrum of ETFs may not be suitable as your investment strategy. But it's a useful guideline for analyzing and monitoring the investment landscape because it's a neutral measure of all, or at least most, global opportunities. Only you (or your financial adviser) can determine what's appropriate for you, but at least there's no mystery about how to begin.

Better than the traditional yardstick

It's a "reasonable" benchmark for asset allocation, says Mebane Faber, chief investment officer at Cambria Investment Management and author of "The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets."

The traditional yardstick is the so-called 60-40 strategy, a domestic mix of 60 percent stocks and 40 percent bonds. But the classic 60-40 portfolio is vulnerable to 21st-century levels of volatility.

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