The Ultimate Buy-and-Hold Strategy - Portfolio 4

It is time to continue putting our ‘investment plan’ into writing. Previously, in Portfolio 3 we looked at blending small- and large-cap stocks in the equity portion of our portfolio based on Paul Merriman’s ‘The Ultimate Buy-and-Hold Strategy‘ workshop which was presented as a webcast online and in the updated article.

Merriman’s next step is to differentiate between “growth” stocks and “value” stocks. Growth companies are those with rising sales and profits and which seek market dominance and are among the largest stocks in The S&P 500 Index. Value companies are those companies that, for one reason or another, are seen as bargains that are expected to return to “normal” levels.

Growth stocks are usually the popular stocks, those that have been bid up by investors wanting to own a ‘good’ stock. Value stocks are those that have become unpopular to investors and can therefore be bought at a bargain. These ‘unpopular’ stocks historically outperform the ‘popular’ stocks.

Normally this is a very subjective call. It is the stuff that ‘active’ managers of investment funds are supposed to be paid to do. The Ultimate Buy-and-Hold Strategy uses a purely mechanical approach to identify value companies. The companies with the lowest price-to-book ratio are classified as value companies.

Therefore, we will create Portfolio 4, the next step in building the Ultimate Buy-and-Hold Strategy, by splitting the equity side of the pie into four pieces instead of two, adding U.S. large value stocks and U.S. small value stocks. This boosts the portfolio’s annualized return by almost a full percentage point, to 12.1 percent, while reducing the standard deviation to 11.8.

So, the bond portion of our portfolio is in shorter-maturity bonds (as per Portfolio 2) and the equity portion is divided between large- and small-cap stocks and between large- and small-cap value stocks. According to Merriman this diversification has improved the return of our portfolio from 10.4 percent to 12.1 percent, or 16 percent! All this with only a very slight increase in volatility.

Merriman does have suggested portfolios available on this web site depending on where you have your investments. Since mine are at Schwab, I have used their fund screener to find out what is available. The following value index funds are available:

Next, in Portfolio 5 we will look at adding international stocks to our portfolio.