By John Wasik
CHICAGO, March 17You can get most of what you
want for your investments from off-the-shelf index funds, but
you may have to dig deeper to make your portfolio more
For most mainstream investors, a focus on S&P 500 index
funds and a general bond market index serves them well. Yet what
if you concentrated on a mixture of different asset classes
instead of only picking the usual suspects in conventional index
funds that hold the most popular stocks and bonds? You may be
able to boost returns while insulating yourself from off years.
An "asset-class investing" approach still relies upon
low-cost, passively managed funds as core vehicles, but it puts
a greater focus on diversification, which could enhance returns.
Giving yourself a piece of every corner of the market means
investing in large-, medium- and small-sized companies in
developed and emerging markets, plus a broad selection of U.S.
and global bonds.
How does it differ? Take the standard approach to indexing
the U.S. stock market. Most financial advisers would tell you to
buy an S&P index fund, which holds the most popular stocks in
the U.S. A good choice would be the SPDR S&P 500 ETF,
which holds a mostly passive portfolio at an expense ratio of
0.09 percent annually.
Since many index funds hold stocks that investors have
assigned the highest values to, you may not be getting the best
prices on them.
What if you shifted to a value approach, and sought
Then you'd want to buy a fund like the DFA US Large Cap
Value I fund, which has beaten the S&P 500 index by
almost 4 percentage points in annualized return over the past 15
years through March 14. Charging 0.27 percent for annual
expenses, the fund has top holdings like Bank of America Corp
, Citigroup Inc and Chevron Corp. Over the
last three years, it's posted an annualized return of nearly 16
percent through March 14.
With this approach, you may realize more upside because
these companies aren't valued as highly as companies like Apple
Inc and ExxonMobil Corp, which top the
popularity contest for U.S. stocks at the moment and sit on top
of the holdings for most big-stock index funds.
Another aspect of the asset-class approach is to spread your
stock allocation across companies of all sizes throughout the
world. Combining a value and small-company stake can also be
Over time, the return advantage of small-cap value over the
S&P 500 index is impressive.
The DFA US Small Cap Value Portfolio, for example,
has outperformed the S&P index by more than 8 percentage points
in annualized returns over the past 15 years. But you probably
wouldn't recognize most of the holdings of this fund, which
include companies like CNO Financial Group Inc and
Esterline Technologies Corp. It costs 0.52 percent
annually in expenses.
THE BIG PICTURE
If there is one theme in asset class investing, it's
ignoring what's popular at the time - whether it's a fund or a
stock - and hewing to a broad picture of the entire universe of
stocks and bonds.
Assuming that the mix of funds matches your stomach for risk
and can beat inflation, pulling everything together is a matter
of finding the best funds in each asset class.
DFA funds, which I've cited above, are good vehicles, but
are only available through advisers. You can find comparable
funds within the iShares, SPDR or Vanguard Groups.
Eric Nelson of Servo Management in Oklahoma City employs
asset class investing for his clients. His approach is mostly
passive, but he tailors each portfolio.
Part of the strategy is holding funds that are sagging at
the moment, like emerging markets or large-company value. This
approach may also entail lower risk since you're not
over-concentrated in the highest-priced stocks on the market.
Nelson estimates that asset-class investing has returned
about 8 percent annually over the past decade, through February,
compared to 6 percent for active management and 7 percent for a
"tactical" strategy that bounces between hot and cold sectors.
"Asset class investing is customized to what you are trying
to accomplish," Nelson says. "And there's no benefit in buying
actively managed funds."
The other key element in the strategy is to be true to the
kind of risk you want to take. The trade-off for investing in
small companies looking for high return is that they involve
more risk in the short term. That's where diversification comes
in. By investing in a wide mix of stocks and bonds, Nelson's
asset-class portfolio lost only 22 percent in 2008, compared to
about 32 percent for active portfolios.
Making this strategy work might entail working with an
adviser to set up a portfolio of low-cost passive funds or
finding a pre-designed portfolio online from services such as
Betterment, Wealthfront.com, folioinvesting.com. Just make sure
that you have a piece of everything: Large, medium and small
companies across the globe and bonds from the U.S. Treasury,
corporations, and emerging markets.