Month: March 2016

The Rationale behind the Simple Six

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Here’s some of the rationale behind the Simple Six portfolio.

As the investor’s expenses are expected to be denominated in Canadian dollars when the portfolio is liquidated, a large part of it is invested in Canadian dollar denominated securities. Recognizing that the Canadian economy is less than 3% of the world’s economy, I think its also important to diversify beyond Canada. Accordingly, a significant proportion of the portfolio is invested around the world, but particularly in the U.S.

The 1,100 bond (fixed income) units represent about 25% of the portfolio. I thought this proportion was about right given the risk-reward profile of the investor. These units are expected to have a relatively low rate of return, but they also carry a relatively low measure of risk. The fixed income portion of the portfolio is also diversified among corporate bonds and governement bonds. The largest fixed income component consists of short-term bonds, as I believe the probability of an interest rate increase is greater than the probability of an interest rate decrease in the next 12-24 months, and short-term bonds decrease less than long-term bonds in such an environment.

The largest equity investment is in 500 units of  Vanguard Total World Stock ETF (VT). Over one-third of the portfolio is invested in this ETF. This is because the ETF covers about 8,000 stocks in nearly 50 countries. So, great diversification.

The second largest equity investment is in 1,000 units of Vanguard FTSE Canada All Cap Index ETF (VCN). This ETF is a market-capitalization weighted index representing the performance of Canadian large, mid and small cap stocks. The coverage of a mixture of variously-sized firms provides better diversification than an ETF made up of only the largest or smallest firms.

The third equity investment is in 100 units of iShares MSCI All Country World Minimum Volatility (ACWV). This also a source of international diversification, but based on stocks whose values are expected to fluctuate less than average.

Keeping only six ETF funds in the portfolio minimizes trading costs and simplifies portfolio monitoring. Yet, the Simple Six provides plenty of risk diversification, while expected to provide a reasonable return over the medium to long term.

 

The Simple Six Portfolio

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I was asked by a friend to put together a simple portfolio. One parameter was that it should not be ‘too risky’, but that did not mean a ‘temporary’ drop of more than 10% below initial cost would be unacceptable. Also, the expected return had to be more than what was currently offered in a savings account at a bank, or what could be obtained by purchasing a GIC – not a difficult target to achieve.

The portfolio was not expected to be liquidated within 10 years, and of course, diversification of risk needed to be achieved. So I came up with the following suggestion, based on an assumed CAD 100,000 available to invest. I called it the Simple Six, because it consists of only six ETFs.

The Simple Six portfolio consists of:

300 units of  Vanguard Canadian Aggregate Bond Index (VAB)

400 units of  iShares Core High Quality Canadian Bond Index (XQB)

400 units of  Vanguard Canadian Short-Term Bond Index (VSB)

1,000 units of  Vanguard FTSE Canada All Cap Index ETF (VCN)

100 units of  iShares MSCI All Country World Minimum Volatility (ACWV)

500 units of  Vanguard Total World Stock ETF (VT)

I’ll explain my rationale in my next post.