It's All in the Mix

A globally diversified index portfolio has historically delivered reasonable returns for the risk that is built into each portfolio. Figure 11-6 plots the risk and reward for 20 index portfolios and various indexes, along with an S&P 500 Index over the 50-year period from January 1, 1968 to December 31, 2017. Note the higher annualized returns of the index portfolios that have had similar risk (annualized standard deviation) as the S&P 500 Index. Also note the returns of the emerging market indexes when isolated on their own (high risk with compensated returns). The index portfolios shown are all comprised of an efficient blend of indexes. Also, note the square buttons that I advise clients to avoid in efficient portfolios.

Figure 11-6


The chart shows the S&P 500 had similar risk characteristics (14.99%) as Index Portfolio 95 (15.16%) but delivered a lower return: 10.12% vs. 11.96%. The S&P 500 Index actually delivered an annualized return comparable to the return of Index Portfolio 65 with 35% fixed income, which shows that similar returns were available at lower risk. A higher annualized return could have been delivered by taking less risk. This chart shows the value of diversifying beyond large cap companies in the U.S., as reflected in the S&P 500 Index. Portfolios 65-95 all delivered higher annualized returns with similar or less risk than the S&P 500 Index. 

Figure 11-7 shows 50 years of monthly return distributions for four index portfolios. These histograms represent 600 months of monthly risk and return data for the 50 years from January 1, 1968 to December 31, 2017. Note the wider bell curve distributions in the higher risk Index Portfolios 100 and 75 as compared to the lower risk Index Portfolios 50 and 25. The riskier portfolios had a larger range of outcomes over time. 

Figure 11-7


This wider range or increased volatility has also carried a higher average return. Of the four portfolios shown, the most risky Index Portfolio 100 had the widest range of monthly return outcomes over the 50-year period. This wider range or increased volatility is the trade-off for higher returns, relative to Index Portfolios 25, 50 and 75 that had lower risk and lower returns. The charts also reflect the growth of a $1 investment in each portfolio over the 50-year period. Remember that an investor’s actual returns will vary from these returns due to the timing of withdrawals and contributions, rebalancing strategies, costs, fees and other factors. 

As was shown in the previous charts and discussions, diversification among low-cost index funds is a very effective means for investing. While one cannot obtain any guarantee of future success based on the past, the 50 or 90 years of data associated with the style-pure index portfolios is arguably, and evidentially, as good as it gets for any investor, individual or institution.

The data table in Figure 11-8 represents the short-term and long-term risk and return data for the S&P 500 and 10 index portfolios with varying degrees of exposure to bonds and stocks. Growth of $1 is also shown for each portfolio. When seeking to construct a portfolio, it is advisable for investors to pay careful attention to the 20, 50 and 90-year data columns on the right hand side. The 50-year return is largely considered the historic return and a good estimate of the future or expected return over 15-year or greater periods. The left columns which show the year-to-date, one-, three- and five-year returns are shown in order to make investors aware of the short-term volatility of the various investments and should not be considered useful for determining which portfolio is right for an investor.

Figure 11-8

Step 11S&P 500Globally Diversified PortfolioPortfolio AllocationsRiskReturnDiversificationVolatility