The Ultimate Buy-and-Hold Strategy - Portfolio 2

We recently discussed the first of five portfolios that Paul Merriman of Merriman Capital Management discussed on the recent online broadcast of his workshop, ‘The Ultimate Buy-and-Hold Strategy’. This strategy is also spelled out in an article of the same name on his website. That first portfolio, Portfolio 1, presented a baseline portfolio consisting of the industry standard 60/40 ratio of equity and bonds.

The primary focus of the online workshop was about allocating the equity portion of your portfolio, but Merriman has a few things to say about bonds before moving on. Bonds are placed in a portfolio primarily to give price stability (as measured by standard deviation), as well as to produce current income. What type of bonds should one include in their portfolio? Merriman says that the bonds with maturities greater than five years do not provide a consistently better return than shorter-term bonds. And what little gain they may provide comes with considerably more risk. He says the best returns are from bonds with maturities between one and five years.

Merriman recommends splitting the bond portion of your portfolio evenly between bonds with maturities up to two years and bonds with maturities up to five years. This mix, he says, can be found in the typical short-term bond fund.

The average maturity of the bonds in Portfolio 1 is between eight and 13 years. Those bonds have considerably more volatility than is warranted for the amount of return they provide. To build the Ultimate Buy-and-Hold Strategy our first adjustment will be to move the bond portion of our portfolio to short-term bonds. Since my investments are at Charles Schwab, I checked the funds they have available and the Schwab Short-Term Bond Market Fund (SWBDX) appears to fit the bill.

The result, based again on 1970 through 2005, is Portfolio 2. This combination has a total return of 10.4 percent, almost exactly the same as Portfolio 1, along with a standard deviation of 10.8 — a bit lower than that of the benchmark Portfolio 1. This gives the portfolio a little more stability and about the same return. (When rounded, the annualized percentage figures are both 10.4. But in fact there’s a small difference, which is reflected in the hypothetical growth of $100,000. We don’t believe that 60 percent equity and 40 percent bonds is the right balance for all investors. Many young investors don’t need any bonds in their portfolios. And many older folks may want 70 percent of their portfolios in bonds. But the 60/40 ratio of Portfolio 1 is nevertheless a very good long-term investment mix. It’s the industry standard, and that’s what we will use as a benchmark in this article.

In the articles to follow in this series we will see what Merriman recommends regarding the equity portion of the Ultimate Buy-and-Hold Strategy.