A simple two fund portfolio

Before I get into the original purpose of this blog entry I would firstly like to highly recommend this article by Fidelity  It describes the importance of diversification and how the addition non-correlating assets can lower the overall risk of a portfolio.

Some important messages include:

1. A simple diversified portfolio of stocks and bonds would have had a smaller draw down than that of just stocks during the financial crisis of 2008.
2. The recovery of the diversified portfolio from 2009 to 2013 is slightly lower but its overall performance is still superior to the 100% stock portfolio.
3. Correlations between assets classes did increase during the financial crisis but importantly they didn't become fully correlated. Diversification still worked!
4. To be able to fully benefit from diversification investors would have had to stick to the asset allocation throughout the bear market instead of being tempted to shift to lower risk assets and then missing the subsequent recovery in stocks.

The following is a suggestion for a very simple diversified portfolio, one fund in bonds and another in stocks. The primary goal is to maximise diversification for minimum cost. We ideally want global exposure, get it as cheap as possible, and exploit the low correlation between binds and stocks.

Starting with stocks we can find:

SPP Aktiefond global, 0.3% fee

AMF Aktiefond global, 0.4% fee

Both hold hundreds of shares from around the role predominantly in the USA, Europe and Japan. If there is any weakness it's that the emerging markets and Asia get a bit less than 10% exposure. Performances over the past 5 years are about the same at roughly 50%.

The only difference is the SPP fund does not invest in companies considered to be unethical such as those involved with weapons and tobacco. So it's up to the investor if this is important to: them or not when choosing between the two.

The next part is the bond component:

Öhman obligationsfond, 0.15% fee

AMF Räntefond Mix, 0.3% fee

Öhmans fund is the cheapest bond fund which invests in Swedish sovereign debt. However, I like the look of AMF's fund which invests in government bonds from not only Sweden but also the rest of Europe and USA. For a slightly higher fee one gets far more diversification. 

The allocation of the two funds depends on ones tolerance to risk; typically more bonds means less volatility and smaller drawdowns. This also means with age the older you are more a higher bond allocation is recommended to lock in gains and reduce any potential loses as retirement approaches.

It will be interesting to see how this type of strategy will work in the future as we are currently in a very low interest rate environment, bonds prices are very high and we have just come through a 30 year bond bull market. The expectation going forward is rising interest rates and big losses for those with investments in bonds.

However, for the moment, the standard portfolio is a 60/40 stock & bond mix but I'm a more of a stock fan so prefer more of a 70/30 allocation.  So here it is

70% AMF Global stock fund

30% AMF Mix bond fund

A simple two fund portfolio that achieves global diversification across two asset class at a relatively low fee of 0.37%. Both allow very small monthly investments, as low as 50 SEK, and being funds no trading fees would be incurred, such as with ETF's.