Portfolio Visualizer is a highly rated online tool for designing investments (ref. 1). I used it to backtest the model portfolios listed in the following chart:
Four-sector models in rows 2-4 represented diversified investments in stocks (VT, VTI), real estate investment trusts (VNQ), investment grade U.S. bonds (AGG), and gold bullion (GLD). Several observations:
- Four-sector models outperformed the bond market as determined by comparing their balances to the $1.32 that would result from investing only in AGG.
- Portfolio performance was affected by the percentages of the index funds. The final balance of four-sector models increased with the total percentage of stocks (VT, VTI) and real estate (VNQ) investments.
- Four-sector models underperformed the benchmark.
The one-sector model in row 5 held diversified investments in U.S. stocks. SCHX is a proxy for U.S. large-cap stocks and VTI is a proxy for all U.S. stocks. Among models, only the final balance of this model surpassed that of the benchmark in row 6.
Four-sector models are ideal portfolios for making short term investments of 1-5 year time periods. The goal of four-sector models is to improve safety by reducing the downside risk of investing in one sector.
The one-sector model of diversified U.S. stocks is ideal for making long term investments of 10 or more years.
Last year’s SmallTrades Portfolio, in 2018, was a four-sector portfolio that underperformed the benchmark. In 2019, the new SmallTrades Portfolio will hold a group of actively managed stocks plus the passively managed Schwab U.S. Large-Cap ETF (SCHX). The initial allocation will be 20% stocks and 80% SCHX.
Thesis: SCHX is designed and tested to match the performance of the benchmark. Successful management of the stocks will raise the portfolio’s total performance above that of the benchmark.
- Vikram Chandrasekhar, 2016. What is the best tool to backtest a portfolio online?
The total return of a portfolio is estimated by the following formula:
RT = aRA + bRB+ cRC + dRD
For example, what is the estimated total return for the following portfolio?;
25% VT + 25% VNQ + 25% AGG + 25% GLD
- a, b, c, and d = 0.25.
- RA = 7.19%, RB = 10.21%, RC = 3.13%, and RD = 1.37%.
- RT = 0.25*7.19% + 0.25*10.21%+ 0.25*3.13% + 0.25*1.37% = 1.80% + 2.55% + 0.78% + 0.34% = 5.47%
By comparison, the Portfolio Visualizer reported RT = 5.93% with a final balance of $1.68.