“Ultimate” isn’t a term to toss around lightly. But in this case it fits. I believe the investment portfolio I’m about to describe is the absolute best way for most investors to achieve long-term growth in the stock markets — and I’ve believed that since the 1990s.
My view is based on the best academic research I know of as well as my own experience working with thousands of investors over the past half century. I’ve been recommending this combination for more than 20 years, and it is the basis of the majority of my own investments.
I’ve got loads of evidence to back up my confidence. The strategy itself isn’t new, and as I do every year, I am updating the results to reflect one more year of data.
In a nutshell, the “ultimate” portfolio starts with the S&P 500 Index SPX, -1.83%, then adds small and equal portions of nine other carefully selected U.S. and international asset classes, each one of which is an excellent long-term diversification vehicle.
The result is a low-cost equity portfolio with massive diversification that will take advantage of market opportunities wherever they are, and at about the same risk as that of the S&P 500.
I like to roll this out in steps rather than all at once, so you can see how it goes together. Here’s a table that might make it easier to follow along.
The base “ingredient” in this portfolio is the S&P 500 Index, which is a pretty decent investment all by itself. For the past 50 calendar years, from 1970 through 20119, the S&P 500 compounded at 10.6%. An initial investment of $100,000 would have grown to nearly $15.4 million.
For the sake of our discussion, think of the S&P 500 index as Portfolio 1. It’s not bad, and you could do much worse. But you can do a whole lot better, too.
An enormous payoff from a small change
You take the first small step by adding large-cap value stocks, ones that are regarded as relatively underpriced (hence the term value).
(The links above, and others below, are to specific articles from 2015 that focus on each asset class.)
By moving only 10% of the portfolio from the S&P 500 into large-cap value stocks (thus leaving the other 90% in the S&P 500), you create what I call Portfolio 2.
Although only 10% of the portfolio has changed, the 50-year return improves enough to be worth noticing. Assuming annual rebalancing (an assumption that applies throughout this discussion), the 10.8% compound return of Portfolio 2 was enough to turn $100,000 into $16.9 million.
In dollars, this simple step adds more than 15 times your entire original investment of $100,000 — the result of changing only one-tenth of the portfolio. If that isn’t enough to get your attention, I don’t know what would it would take.
In the next step we build Portfolio 3 by putting another 10% into U.S. small-cap blend stocks, decreasing the weight of the S&P 500 to 80%. Small-cap stocks, both in the U.S. and internationally, have a long history of higher returns than the stocks of larger companies.
This change boosts the 50-year compound return of the portfolio to 11%; an initial $100,000 investment would have grown to nearly $18.1 million — an increase of $2.7 million from Portfolio 1.
Taking still another small step, we add 10% in U.S. small-cap value stocks, reducing the weight of the S&P 500 to 70%.
Small-cap value stocks historically have been the most productive of all major U.S. asset classes, and they boost the compound return of Portfolio 4 to 11.3%, enough to turn that initial $100,000 investment into $21.6 million.
With more than two-thirds of the portfolio still in the S&P 500, that seems like a marvelous result.
In the next step, creating Portfolio 5, we invest another 10% of the portfolio in U.S. REITs funds. Result: a compound return of 11.4% and an ending portfolio value of $22.3 million.
Let’s pause for a moment to recap.
• First, Portfolio 5’s increase in compound return over Portfolio 4 was small, but over 50 years that tiny step produced an additional $708,000. This is a lesson I hope you won’t ever forget: Small differences in return, given enough time, can add up to big differences in dollars.
• Second, Portfolio 5, with its substantially higher return, had essentially the same risk level as the S&P 500 Index. Higher returns, without adding risk, has to be a winning combination.
You could stop here
Some investors may wish to stop here and not invest in international stocks. If that’s the limit of your comfort level, that’s fine. The combination of asset classes in Portfolio 5 is excellent, and I expect it will do well in the future.
But I believe any portfolio worth being described as “ultimate” must venture beyond the U.S. borders. And the rewards have definitely been there.
Accordingly, in building the ultimate equity portfolio I add four important international asset classes: international large-cap blend stocks, international large-cap value stocks, international small-cap blend stocks and international small-cap value stocks.
Giving each of these a 10% weight reduces the influence of the S&P 500 to 20%. If that sounds frightening, think about this: Over 50 years, the changes I just described (Portfolio 6) increased the compound return to 12%, and the portfolio value to $29.4 million.
That is an increase of 91% over the S&P 500 by itself. And Portfolio 6 produced that result with only a slight increase in statistical risk.
The final step, which results in Portfolio 7, is to add 10% in emerging markets stocks, representing countries with expanding economies and prospects for rapid growth. While this asset class has been a laggard lately, in eight of the most recent 20 calendar years, it was either the top-performing equity asset class or No. 2.
This additional slice of emerging markets stocks boosts the compound return to 12.6% and brings the final portfolio value to a whopping $37 million — nearly 2.5 times that of the S&P 500 alone.
That’s the Ultimate Buy and Hold Portfolio, which over nearly half a century obviously stood the test of time very well.
As you will see, Table 1 includes another column, labeled Portfolio 8. This is my suggested All-Value Portfolio, which includes only five asset classes instead of the 10 in Portfolio 7. Portfolio 8 starts with Portfolio 7, then eliminates REITs and the blend asset classes. The 50-year performance of Portfolio 8 is slightly less than that of Portfolio 7, but still stunning at 12.6% in compound return and a final value of just under $37.1 million. Portfolios 7 and 8 are among the results of my long-standing commitment to find higher expected rates of return with little or no additional risk.
Investors who build either of these portfolios using low-cost index funds or ETFs don’t have to rely on anybody’s ability to choose stocks. Nor must they make economic or market predictions.
Obviously, all these performance statistics are based on the past. Will we see returns like these in the future? Nobody knows.
However, every academic I’m familiar with expects that, over the long term, stocks will continue to outperform bonds, small-cap stocks will continue to outperform large-cap stocks, and value stocks will continue to outperform growth stocks.
Depending on your need for return and your risk tolerance, Portfolios 7 and 8 are the best ways I know to put those insights to work for you.
It’s easier to describe this strategy than to implement it in real life. You’ll get an excellent start with this article, in which my friend and colleague Chris Pedersen identifies the best-in-class exchange-traded funds for all these building blocks.
There’s much more to say on this whole topic, and I hope you’ll check out my podcast “10 more things you need to know about the Ultimate Buy and Hold Strategy.”
Richard Buck contributed to this article.