The Model Portfolio of Simplicity & Elegance

by Wes Bridel on April 27, 2011

in Stewardship

The Model Portfolio that you choose should not be one based upon a Wall Street generated cookie cutter, but instead should be based on the key themes that you want to protect against and take advantage of in these crazy economic times. We began with the deflation protection portfolio that Jack & Betsy put together.  Today, we look at a portfolio for varying environments…

Bill & Charity are in their early 40’s and some people think they never graduated from the terrible two’s because they are so strong willed!  They feel like they’ve been riding stock market waves for most of their lives.  When their careers had progressed to the point where they could start putting money into investments, they were thrilled to see just how fast their money multiplied when the market is booming.  That was before about ten years of their investments going absolutely no where.  Correction, plunging like the biggest roller coaster in the park and then screaming back up to just below where they started.  The statement might read the same amount as what they had ten years ago, plus what they’ve been putting in since, but getting here wasn’t easy.

They want a model portfolio that they can set up once and not think about it too often so that they can get on with living their lives.  There’s one problem though.  Bill has been reading about the dangers of severe inflation and dollar devaluation coming and is convinced that this is the threat (with corresponding opportunity) that they need to prepare for.  Charity on the other hand sees everything crashing around her and can’t imagine a possibility where the US Dollar is not at least somewhat strong, steady, and available at a reasonable interest rate.

They have totally opposite views on the economy and therefore the best way to invest!  This might seem like a problem, but Bill and Charity are excellent at working through such differences of opinions.  Charity proposes that they design a portfolio that addresses both of their concerns and is thus prepared for anything.  This type of portfolio wouldn’t do as well as the one either might design on his own (if that person was the correct one), but should hopefully be balanced enough to smooth out the waves that they are absolutely sick of.

Bill and Charity decide on a portfolio that protects against both deflationary and inflationary environments while preserving capital and having a portion of the allocation which responds well in all environments.  They call it “The Simple & Elegant Portfolio.”  It is kept uncomplicated so that it can be a hands off portfolio which is reallocated infrequently.

Here’s the allocation of their Model Portfolio:

A Total Return Fund

An Emerging Market Bond Fund

A Gold & Silver Trust

A Gold Producers Fund

An Emerging Markets Stock Fund

Bill thinks they should reallocate each holding back to its original percentage (20%) once a year, but Charity thinks it makes more sense to give the winners a little more time to ride and believes they should plan to do reallocate (back to 20% each) whenever one holding increased to more than 10% above its ideal percentage weight within the portfolio.  Of course, they don’t agree!  But I know they’ll find the right plan for them.

Let’s examine this model portfolio a little closer…

This model portfolio has five weightings, but because of crossover has equal amounts in:

1)      bond related funds,

2)      gold and silver related funds, &

3)      emerging markets related investments.

Charity feels that the bonds provide some stability and she was even willing to have a larger than normal allocation to emerging market bonds to appease Bill’s very reasonable fears even knowing that this will certainly make the portfolio a little more volatile than she would like.  Even with all the bonds, Bill feels that this allocation still heavily investing in a couple of the biggest growth stories he sees in the coming decade (precious metals and emerging markets).  The specifics of this model portfolio look like this…

The total return fund is a mostly US bond fund, however it does give the manager leeway to take advantage of opportunities as he sees them.  Charity chose this over a more standard US long bond fund because she knows Bill is more concerned about inflation than deflation over the coming decade and believes in his discernment on these things.

The emerging bond fund lends money to countries in “emerging markets”.  Because these have traditionally been basket case economies that sometimes don’t pay back their debts, they pay higher interest rates (by several points) than established western countries.  However, once Bill points out to Charity that these countries actually have sounder financial balance sheets and monetary policy than the “First World”/Western countries, she agrees that the risk and added volatility is well compensated by the extra return.  So although anyone can default on a loan, it seems crazy that they can get a higher interest rate loaning money to a country with a better balance sheet.  The other nice thing is that because Bill feels that the US Dollar might be drastically devalued, this allocation diversifies away from the Dollar and would gain substantially if the Dollar fell (and would likewise lose value if the Dollar rose.)

The gold and silver trust provides the safety and security of real money locked in the vault to this model portfolio.  It also provides protection against the value of the Dollar falling.  It seems like the safest place to be in this crazy economy to Charity who knows that gold always has been real money.

The gold miners fund takes this one step further.  Bill says, “If gold is going to increase in value, why not own the companies who own the most gold?”  Although these miners are more risky (and therefore go both up and down more than gold) they can do extraordinarily well if the price of gold takes off.  Bill wants to be positioned to take advantage of this move which he believes is coming.

Finally, the emerging market fund looks to ride the coattails of the “third world” joining (surpassing?) the first world at the table.  These countries have seen booming economic growth over the last decade as the western world has stagnated and Bill feels like that is a story that will continue.

In a deflationary environment and when stock markets are crashing, this fund would probably fare worse than the Jack and Betsy’s, but since Bill and Charity as family feel that a dollar devaluation, high inflation, and more are all possible scenarios, they feel that this mix gives them the simplest way to protect against all risks and hopefully grow their capital in trying times without having to constantly hover and worry over their investments.

This is Part 2 in a series on Real Life Examples of Portfolio Management.  You can read Part 1 here.  We just finished a series on the different types of investors which you might want to check out at the following links:  Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, & Pt 6.

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