There are many theories on creating the best investment portfolio. Here is one that is well balanced, and well suited to surviving the financial fluctuations of these times. It is called the 7Twelve® portfolio. It was first formulated by Craig L. Isrealsen,PhD. an Executive-in-Residence in the Financial Planning Program in the Woodbury School of Business at Utah Valley University. Overall, he has over 25 years of experience in the financial industry.
Professor Isrealsen created this approach to maximize the benefits a diverse portfolio can offer. He likens this approach to a good salsa recipe. “The broad diversification of the 7Twelve® model is more important to its performance than picking the “right” funds. Very simply, the recipe is more important than the ingredients.”
Good ingredients + poor recipe = poor salsa/poor portfolio results
Good ingredients + good recipe = good salsa/good portfolio results
A 7Twelve® portfolio includes 7 core asset classes and consists of twelve different ETF’s or mutual funds (funds). Each of the twelve funds are equally weighted and the portfolio is periodically rebalanced to maintain an equally weighted structure.
Some of the benefits and objectives of the 7Twelve® portfolio include being able to produce long-term equity-like results with less volatility than equities. Compared to equities, this approach minimizes the frequency and the magnitude of losses thus delivering a more consistent performance over a rolling 3-year period of time. Maintaining a consistent portfolio with a philosophy of broad diversification will also help investors avoid fads and performance chasing.
When assembling a balanced portfolio often its key elements are equities and fixed income assets. The seven core asset groups with their twelve associated funds are: US equity: large-cap US, mid-cap US, and small-cap US; Non-US equity: Non- US developed, and Non-US emerging market; Real Estate: global real estate; Resources: natural resources, and commodities; US bonds: aggregate US bonds, and inflation protected US bonds (TIPS); Non- US bonds: international bonds; and Cash: US money market.
This arrangement will allocate 8 equity and diversifying funds- which is 65% of the overall portfolio, and 4 fixed income funds- which accounts for 35% of the portfolio. A 65/35 allocation balance will bring together more stability and less risk in a solid combination that, over the long haul, has a proven track record toward steady growth even in volatile times, such as we are experiencing now.
Each of the 12 funds is equally weighted at 8.33% of the portfolio. The equal-weighing is maintained by periodically re-balancing each of the 12 funds back to an 8.33% allocation. Quarterly or annual re-balancing generally produces the best performance, whereas monthly re-balancing is too frequent.
Re-balancing is an important part of the 7Twelve® investment strategy. Re-balancing helps to accomplish the goal of buy low and sell high. As sectors grow some is sold off to bring the portfolio into balance; the other sectors that are performing poorly get some new money to bring them up to the balanced amount. Nearly all sectors take their day in the sunshine, that of being the best performing asset. By keeping the portfolio balanced, each one is ready for their day to shine.
Re-balancing can also be done by simply adding new money to funds to re-create the 8.33% balance; or, if one is in their retirement years to simply withdraw money from the best performers whereby restoring the 8.33% balance.
Let’s face it, we are emotional creatures by nature, and most investors too are emotional about the decisions to buy or sell. Re-balancing is a fantastic tool that may help with the emotional roller coaster. Using systematic guidelines to monitor the portfolio increases the chance for success. Any assistance with the emotionally charged buy/sell decisions that may chip away at an investors overall gains is helpful. Trying to outsmart the market tends to do more harm than good; nobody can beat randomness at any given time. Having a steady plan to follow will help the investor to safely navigate the years it takes to grow their investment.
One of the main challenges of encouraging an investor to build a multi-asset portfolio is that the portfolio will never outperform the best performing individual asset class in any given year. Multi-asset portfolios are steady, not flashy. Nervous investors who are constantly looking over their shoulder may feel the need to chase last year’s best performing asset class and invest some or all of their portfolio into them. However, the winner last year is typically not the winner this year. This type of roller-coaster investing will surely lead to disaster.
Building a diversified portfolio is the only logical investment philosophy—both emotionally and mathematically. The emotional swings caused by chasing the performance of individual asset classes should be obvious, but the mathematics may not be.
The mathematical evidence supporting the wisdom of a steady multi-asset portfolio vs. performance chasing is simply put: asset classes that have huge gains also tend to also have large losses in subsequent years—and the math of gains and losses is NOT equal. For instance, a 50% loss requires a 100% gain to get back to the starting point.
Therefore, avoiding large losses is one of the key reasons for building a broadly diversified portfolio. Individual asset classes have great years (such as US stocks in 2013) but next year may not produce similar results. A steady, well diversified portfolio will win in the end.
The 7Twelve® portfolio recipe for investing has a proven track record and is well worth looking into if you haven't already. Give us a call if you think this portfolio model will help you, and as always, do your own homework before you decide to invest.
7Twelve is a registered Trade Mark by Craig Israelsen and is used by Wendell Brock by a licensing agreement.