This nearly effortless strategy will by far give you the best 'bang for your buck' in terms of time and effort required for its implementation and the portfolio return you get. Most people shun this approach though as it is seen as boring and to be honest just too easy.
I personally use this approach for a significant part of my investments such as pensions and children's savings. I use other strategies also which I will go into at a later date.
If you haven't already guessed it's a diverse portfolio of index funds held and rebalanced over the long term. No doubt some of you are already thinking about leaving this webpage, disappointed I haven't revealed a new and exciting strategy that will help you multiply your money over the next few months.
You may be surprised to hear though that this approach will crush the far majority of private investors in the long term. Why? History has shown us they (unsuccessfully) try to time the market, jump in at the top, run away when prices get cheaper, spend too much on commissions and chase after the latest hot tip with high hopes for the future.
Past performance also shows us that you will also beat most fund managers, especially after fees are taken into account. Of course, just matching an index and getting an 'average' return is not appealing to investors and doesn't feel a worthy goal for investing.
The big irony however is achieving an index return over the long term would put you in the high performing category of investors as most fail to match that simple benchmark. Check out the graphs below, shocking isn't it?!
Investor returns are a mere half of S&P 500 index, even less when it comes to bonds! Simply focusing on reducing that behaviour gap will give you huge returns over the long run.
To close this gap the investor must switch off their emotions, any thoughts on what the market will do next and pretty much just do one thing, relentlessly keep on buying and rebalancing. (Sounds simple doesn't it, but it's fraught with dangers as the human mind will want to tinker and want to predict - see pitfalls below).
It requires absolute discipline. Whatever the market sentiment, up or down, bull or bear, new highs, new lows, with no emotion you keep on moving forward, saving month after month, accumulating more and more index funds/ETFs for your portfolio. Overtime it will grow and grow and you won't have to think twice about what the market will do next.
Follow these steps to set up your 'Terminator Portfolio'
1. Asset allocation: First step is to choose the mix of bonds and equities. This depends on your age, risk/volatility tolerance and time frame. The younger you are, the more risk you are willing to take and further out in time you plan to use the money the greater the % of stocks. A very general guideline is your age in bonds, so for example someone who is 30 would have 30% of portfolio in bonds. This can of course be adjusted plus/minus 10%, I prefer a higher amount in equities.
2. Costs are key to higher longterm returns, the cheaper the better so choose low cost index funds and ETFs; keep that obey for yourself and your investments. will smaller portfolios it is better to focus of funds rather than ETFs so as to keep commision charges low.
3. Diversify the asset classes over different indices.
Bonds: Sovereign bonds, High quality corporate bonds, Low quality 'junk' bonds
Stocks: US, Europe, Asia, Emerging Markets, Small Cap and Value.
For example (there are many ways of doing this; the simplest example being a mix of Total world equity index/Total international bond index)
20% Sovereign bonds
5% Corporate bonds
20% US equities
20% European Equities
20% Asia
15% Emerging markets
3. Re-balance periodically. There is no hard or fast rule when and how to do this. One approach is to do it on an annual basis, another is to wait until there is more than a 10% deviation in the set allocation. For example emerging markets may be set at 20%, but has fallen by 2% to 18%. Sell those funds that are above their set allocation and use the money to buy more emerging market stocks.
This approach exploits the fact that asset class performances revert to the mean so rebalancing forces the investor to sell high and buy low.
Some pitfalls to avoid:
1. Timing the market, such as equity indices are now at new highs so reduce their allocation in prediction of a pullback. You will most likely fail.
2. Failing to rebalance. US equities performed really well in 2013. It may be tempting to keep any growing allocating as you want to capture any future outperformance. You will miss the next reversion to the mean of the underperforming assets.
3. Overconfidence. Believing you can tweak the strategy to improve the returns with adhoc decisions making e.g. timing, predicting the next turn, watching the news; or even outperform it by buying individual securities. I'm not saying it definetly can't be done but you will now be swimming with the sharks, one of them being your own behaviours and biases! Prove you can do it first before changing the whole portfolio.
4. Pulling you money out at the market bottom during the next bear market, the worst and hardest of all. Seeing your portfolio cut in half is most likely going to freak you out, especially if there aren't many years left to retiring. Unless you really need the money do not start selling your funds/ETFs. Keep rebalancing, some assets will perform better (or less worse!) that others. Even better you should still be putting in your monthly savings. You will actually now be buying more stocks/bonds for the same amount of money. You should get handsomely rewarded for this in the future.
Well that's about it, a simp mechanical portfolio that will terminate most of your peers and even some professionals!
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