A portfolio helps you diversify your risk. A concentrated portfolio made of a few stocks can generate outsize gains or losses. By creating a portfolio made of a proper mix of stocks and bonds it is possible to minimize the risk as while one group of investments goes down, another one can go up. For example, when stocks go down, bonds go up. Diversification can also be achieved by buying stocks from different geographies that have low correlation like US and Japan.
Using Market Awareness, Relative Strength and Buy/Sell Signals you can select which stocks or bonds you should consider buying for outperformance. By combining stocks and bonds that have low or inverse correlations in a portfolio, you can reduce risk.
Buy & Hold Portfolio
If you prefer passive investing and want to construct a simple portfolio that you can buy and hold for a long time (10+ years) you can consider the following
| Asset Type | Allocation % |
| US Stocks | 60 |
| US Bonds | 40 |
An investment of $10,000 in this portfolio in 2008 would have resulted in a gain of $9,507 in 2018. During this 10-year period the maximum drawdown of this portfolio would have been -29.10%.
Compare this with a 100% investment in US Stocks in the same period. The $10,000 investment would have resulted in a gain of $11,612 with a maximum drawdown of -48.27%.
You can see that by adding bonds to the portfolio the drawdown was reduced by around 40%!
Dual Momentum Portfolio
If you are an active investor and are willing to spend some time following rules to switch investments based on the market momentum, you can consider a simple dual momentum portfolio.
The idea in this model is to consider three markets, US Stock Market, World Stock Market (minus US) and US Bond Market. Each month compare the return of the US Stock Market and World Stock Market (minus US) over the past 12 months. Then take the greater of the two and compare its return with 12-month US Treasury Bills rate. If the return of the selected stock index is greater than the Treasury Bill return, invest in that index. Otherwise invest in bonds.
You can use the Vanguard S&P 500 Index fund (VFINX) for US Market, Vanguard Total International Stock Index fund (VGTSX) for World Stock Market (minus US) and the Vanguard Total Bond Market Index fund (VBMFX) for US bonds.
The 12-month US Treasury Bill rate can be obtained from US Treasury’s web site https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield.
From the chart below that compares the performance of the US S&P 500 vs International Stocks you can see that US stocks outperformed their international peers. Then compare the US stock performance over the last 12 months of 7.33%, with the 12-month US Treasury bill rate of 0.18%. Clearly US stocks are where you should invest.
An investment of $10,000 in this portfolio in 2008 would have resulted in a gain of $9,565 in 2018. During this 10-year period the maximum drawdown of this portfolio would have been -17.20%.
Compare this with a 100% investment in S&P 500 Stocks in the same period. The $10,000 investment would have resulted in a gain of $11,331 with a maximum drawdown of -48.47%.
You can see how the dual momentum portfolio reduced the drawdown by around 65% as compared to only investing in US stocks.
Portfolio Visualizer Tool
I have found this free tool to be especially useful in constructing and back testing various portfolios. Based on your goals and investment horizon you can consider various portfolios on this site and see which one best meets your needs – https://www.portfoliovisualizer.com/examples