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My Strategy Lab index portfolio, three years later: a smoother market ride

Andrew Hallam is the index investor for Strategy Lab. Globe Unlimited subscribers can view his model portfolio here and read more in the series online here.

Investing is much like a continental road trip. Sometimes, the sun shines and tailwinds make it easy. Other times, storms force a retreat.

Three years ago, we began our Strategy Lab journey. Four investors built portfolios. Chris Umiastowski's job was to build a growth portfolio. In that journey across the continent, he takes a fast and sleek Kawasaki Ninja. Norman Rothery selected a portfolio of stocks based on low price-to-earnings and book values. His touring Harley-Davidson has more stability. John Heinzl's portfolio of dividend paying aristocrats is a fully loaded BMW touring bike.

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Wanting four wheels safely on the ground instead, I built a portfolio of index funds. It's like an SUV. It's also a portfolio that anyone could build – and keep for an investment lifetime.

The first wheel is a Canadian stock market index. The second is a U.S. index. The third is a developed-world international index and the fourth represents emerging markets. A topless SUV without proper doors might be faster and lighter. But bad market weather could make the ride unpleasant. That's why I keep one third of my portfolio in a Canadian bond market index. It's my doors and roof. Bonds may reduce returns but they increase stability.

During the past three years, global stocks have risen. As of Aug. 31, my U.S. stock market index was up 84.6 per cent. My developed-world international index gained 46.3 per cent. Canadian stocks are up 15.5 per cent. Emerging markets gained 10.2 per cent. My bonds, as expected, barely budged.

Motorcycling speedsters Mr. Umiastowski and Mr. Rothery are many miles ahead. But I can see Mr. Heinzl's rain-battered bike from the dry leather seat of my SUV. Inclement markets have dropped many of his high-dividend-paying stocks. After three years, the dividend stock portfolio has gained about 30 per cent, including all dividends. That's about the same return as my index fund portfolio – even though I have just 67 per cent invested in stocks.

One great thing about a portfolio of index funds is that you never have to wonder what to buy or sell. Just set your goal allocation and stick to it. For example, my Vanguard FTSE Canada ETF (VCE) has dropped 9.6 per cent during the past 12 months. None of my other index funds has had such a big drop. Instead of pondering over the investment's dividends, growth forecasts or tea leaves, I am adding more money to it.

The proceeds come from my portfolio's cash component (thank you dividends) and from my Canadian bond market index. While stocks have fallen, bonds have slightly risen. My Vanguard Canadian Short Term Bond ETF (VSB) has gained 3.2 per cent over the past 12 months.

By rebalancing once a year like this, I sell a bit of what's hot and buy a bit of what's not. This ensures that, over time, I pay less than an average price for my shares. Consider what happens to a portfolio split in two – half in bonds, half in stocks. If the bonds averaged 2 per cent a year and the stocks averaged 4 per cent a year, you might assume that a portfolio split between the two would earn exactly 3 per cent. After all, that would be the average. The actual results, however, would be better than that.

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Gregg Fisher, writing for CFA Institute, reported that in the 20 years ending 2014, U.S. stocks averaged a compounding return of 8 per cent annually. Emerging market stocks earned about the same. But if a portfolio were split evenly between the two, and regularly rebalanced, the investor would earn close to 9 per cent.

Institutional money manager Ben Carlson gives another example. He looked at portfolio performances for U.S. large cap, U.S. medium cap, U.S. small cap and international stocks, as well as real estate investment trusts. Between 1979 and June 30, 2013, these asset classes averaged a compounding return of 11.3 per cent a year. But if they were rebalanced once a year, the portfolio's compounding return would have been 11.7 per cent.

A responsible portfolio devoted 100 per cent to individual stocks or stock market index funds should beat a multiasset-class portfolio, such as the one I built for Strategy Lab. But over an investment lifetime, the gap won't be massive. And let's not forget the ride. It's safer, dryer and more comfortable from the seat of an SUV.

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