A Better Balanced Fund

Craig Israelsen has an interesting idea: Let’s leave 1950 behind.

The associate professor at Brigham Young University in Utah thinks it is time to include the world outside the United States, among other things, in our investments rather than just talk about it.

In a brief paper last year he urged junking the traditional balanced portfolio— 60 percent domestic equities and 40 percent domestic bonds— for a new model. A broader selection of assets, he said, would provide a higher return with less risk.

This is accomplished with what Israelsen dubs the “7Twelve Balanced Fund.” Rather than having just domestic stocks and bonds, the new benchmark has seven asset classes. Those asset classes, in turn, are sub-divided into a dozen sub-sets, all held in equal amounts.

And the payoff is huge.

Over the last 10 years, his better balanced index provided a return of 7.52 percent annualized. Even as it did better than nearly 60 percent of its managed competitors, the Vanguard Balanced Index fund returned only 2.64 percent over the same period.

That 7.52 percent return would have ranked Israelsen’s passive index in the top 2 percent of all moderate allocation funds. Indeed, it would have ranked in the top 30 percent of all world allocation funds— funds that do invest in a broader menu of assets (the table below shows the figures).

Of course, this wasn’t just any 10 year period. Just as there have been periods where foreign stocks and bonds, commodities and real estate provided higher returns than domestic stocks and bonds, we may have future periods where domestic assets provide higher returns than foreign assets, real estate and resources. This is no guarantee of investment nirvana— but it’s a good start for a new millennium.

One reason it has taken so long to modernize the traditional balanced fund is simple. What seems obvious today would have been difficult to do only a few years ago. As recently as 10 years ago many of the index investing vehicles we now take for granted did not exist. Today there are over 900 exchanged-traded index funds. These funds allow you to invest in virtually any slice of a market you can imagine, including the kinds of assets that Israelsen used to build his broader balanced portfolio.

Ten years ago there were only 32 exchange-traded funds. Twenty years ago there were only 12 index funds of any kind. Things change.

Some readers are probably thinking, “Gee, this seems familiar.” It is. The original two-part Couch Potato portfolio was introduced in September 1991. With it you could become your own money manager and beat about 70 percent of professional managers simply by dividing your money in two equal parts and committing to two low-cost index funds, one for stocks, and one for bonds. (And, yes, you are allowed to use a hand-held pocket calculator to divide by 2.)

To honor the Buffett named Jimmy, I added foreign equities and created the Margarita portfolio in 2004. Managing this portfolio is still easy, thanks to the abundant practice many of us have making the most popular drink in the Southwest.

Making portfolios with up to six Couch Potato Building Blocks was introduced in 2005 and further expanded to ten blocks in 2007.

The common denominator here is simplicity. Whatever the number of blocks, you always invest equal amounts in low-cost index funds. That would be up to 10 blocks with the Couch Potato portfolios, or an even dozen with the 7Twelve balanced fund.

Doing this on your own 10 or 15 years ago would have required some fancy footwork. You would have had to substitute some managed funds in some categories. Today, it’s pretty much a slam dunk to build any of these portfolios—and you’ll keep your annual investing expenses under about 40 basis points, or 0.40 percent.

The return you save— and the money you grow— will be your own. You can check the trailing returns of all 9 Couch Potato Building Block portfolios, updated monthly on my website. You can read more about the 7Twelve portfolio on its website, www.7twelveportfolio.com.

Old World vs. New World Balanced Funds

This table compares the annualized returns of a 12 component balanced fund with the traditional 60/40 domestic balanced fund. The returns of the Vanguard Balanced Index fund reflect annualized expenses of 0.25 percent. The 7Twelve Balanced Index is based on index returns.

While Israelsen has written to say that his portfolio is stated in terms of ETF returns after expenses, he doesn’t name the ETFs in his paper and I doubt very much that all 12 ETFs he uses existed at the end of 1999.

Measure 7Twelve Balanced Index Vanguard Balanced Index
2009 25.24 percent 20.06
3-year-annualized return 1.02 (0.28)
5-year-annualized return 5.93 2.87
10 year-annualized return 7.52 2.64
Number of negative years 3 4

Next week: Building Block Portfolios on Different Platforms