PORTFOLIO
Big Four
Four different asset classes yielded widely varying returns
over a 10-year period.
Annual Returns
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Annualized 10- Year
Return (%)
10- Yr. Standard Deviation
Of Annual Returns (%)
Vanguard
Total Stock
Market Index
- 20. 96
31. 35
12. 52
5. 98
15. 51
5. 49
- 37.04
28. 70
17.09
0.96
Vanguard
Total Bond
Market Index
8. 26
3. 97
4. 24
2. 40
4. 27
6. 92
5.05
5. 93
6. 42
7. 56
Vanguard Total
International
Stock
- 15.08
40. 34
20. 84
15. 57
26. 64
15. 52
- 44. 10
36. 73
11. 12
- 14. 56
Average of
20 Non-U. S.
Bond Funds
13. 88
13. 83
8. 77
- 2. 26
5. 17
7. 45
0.32
11. 25
5. 91
2. 83
3. 75
5. 49
5. 86
6. 59
21. 13
1. 83
26. 34
5. 45
Source: Morningstar Principia, calculations by author
asset portfolio that included only U.S.
stocks produced a 10-year average
annualized return of 3.75% from 2002
through 2011.
Next, U.S. bonds are added to create a two-asset portfolio with a classic 60% stock/40% bond allocation.
(The funds were rebalanced back to
their starting allocation percentage at
the end of each year.) In this portfolio,
the 10-year return increases to 5.06%,
and the standard deviation of return
is cut nearly in half, to 12.48% from
21.13%. More return with less volatility: What a great idea!
For the third step, non-U.S. stocks
are included, with an allocation of
40% U.S. stocks, 20% non-U.S. stocks
and 40% U.S. bonds. The return of
this three-asset portfolio increases to
5.63%; the portfolio’s volatility also
increases, although only fractionally.
(Again, each asset was rebalanced
annually to its starting allocation.)
Finally, non-U.S. bonds are added
to the mix. This final asset allocation
model consists of 40% U.S. stocks,
20% U.S. bonds, 20% non-U.S. stocks
and 20% non-U.S. bonds (with annual
rebalancing). At this stage of the anal-
ysis, each of the 20 non-U.S. bond
funds was employed one at a time,
and the overall portfolio performance
was measured 20 separate times.
For example, the 10-year annualized
return of a portfolio consisting of 40%
Vanguard Total Stock Market Index
Fund, 20% Vanguard Total Bond
Market Index Fund, 20% Vanguard
Total International Stock Index Fund
and 20% Oppenheimer International
Bond Fund was 6.56%. The standard
deviation of the annual returns was
14.35%, and the worst one-year return
was - 22.76%.
focus on maturity
In fact, among the seven non-U.S.
bond funds that failed to add value to
the three-asset portfolio, one characteristic stands out: a shorter average
maturity. The average maturity of the
13 bond funds that added value was
8. 2 years, while the average maturity
in the seven funds that did not add
value was 5. 6 years.
The non-U.S. bond funds that had
an average maturity that was closer
to that of the Vanguard Total Bond
