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Is a Core-4 Investment Strategy For You?

Oct. 18, 2013
Investing, Investments
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Whether you’re saving for retirement, or your child’s college fund, or just want to put some money in the stock market, there are compelling reasons for picking a position and sticking to it. According to a study released by the Schwab Center for Financial Research, for any 20- year period between 1926 and 2011, the S&P 500 never produced a negative result. To achieve a solid return, though, you must do more than just choose a security. Many advisors recommend dividing your portfolio between a core group of funds, which provide diversification and can be rebalanced to accommodate different levels of risk.

What should this portfolio consist of? How many funds do you really need to create balance? Some experts advocate a core of seven, and others have suggested six funds that should cover your bases. To simplify even further, Forbes columnist and CFA Rick Ferri has proposed a core of just four diversified funds that should suit your changing needs for risk.

What are the Core-4?

Ferri’s four core picks are: 

  • Vanguard Total Bond Market Index: This Vanguard fund consists of 6,042 bonds, about 30% of which are corporate bonds and about 70% of which are US government bonds, with a variety of maturity dates. Since its inception in 1986, it has had an average annual return of 6.46%
  • Vanguard Total US Stock Market: Founded in 1992, this fund consists of the 3,639 small-, mid- and large-cap stocks that make up the US market. It has achieved average annual returns of 9.12% over the past 11 years.
  • Vanguard Total International Stock: This fund gives investors access to 5,538 stocks from developing and emerging markets, including Shell, Novartis, Vodafone and Toyota. Since it was founded, it has produced an average annual return of 4.93%.
  • Vanguard REIT Index: Vanguard’s REIT fund is made up of 127 stocks, and has had an average annual return of 10.45% since its inception.

Investing in these four funds – or four similar funds through another brokerage – takes all of the guesswork out of diversification by covering major asset classes. Between bonds and international stocks, they also offer a wide variation in risk.

How Do You Allocate Your 4 Funds? 

You can further tailor this portfolio by adjusting your stock and bond allocation each year, in order to optimize your risk-return profile. Many advisors recommend that your portfolio’s bond allocation equal your age, so at 40, you should invest 40% of your portfolio in bonds, and so on. The rest should be made up of stocks.

You can also adjust your equity allocation to match your risk tolerance. Ferri suggests allocating the majority – about 36% of the total portfolio – to the Total US Stock Market Fund, with about 18% and 6% going to international stocks and REITs, respectively. However, since REITs and international stocks tend to be more volatile, you can put more money into them if you’d like to take on more risk.

Who Should Use the Core-4?

Active investors will definitely not be interested in the Core-4 strategy; neither will people who have a lot of ground to make up on their portfolio in a relatively short time. If you’re only an occasional investor, though, and would prefer to spend a minimum amount of time managing your portfolio, the Core-4 could provide a low maintenance solution. 

Does the Core-4 Work? 

Yes, as it turns out. Ferri runs the numbers and they’re encouraging. According to his calculations, users of the strategy could expect between a 5.4% and a 3.1% return on their investment during the first decade of the 2000’s, which wasn’t kind to markets in general. The Core-4 even weathered the recession well. Between 2007 and 2009, only the most aggressive investors – with portfolios composed 70% of stocks – lost money, and even these investors lost only 0.8%. Those invested more heavily in bonds managed to gain up to 2.4% during those years. This compares very favorably to the market return of the S&P 500, which was down 21.3% for the same three-year time period.

Broad diversification and managed risk are always elements of a solid portfolio, regardless of whether your core consists of four funds or more. But if you’re looking for an easy-to-manage portfolio that generates predictable returns over the long term, you should consider the Core-4.


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