(Original post February 4th 2016. Updated December 31st, 2016. If the below interests you be sure to listen to Ep 4 on my podcast here).
I created an oh$hit sample investment portfolio for you. This portfolio should lose less in a recession than a typical portfolio that is investing in generic stock funds. It will also make less if the stock market takes off.
This is not a "buy" recommendation. This is to show you how I came up with this portfolio so you can play around with it and make one on your own. In other words, don't sue me.
I put this oh$hit portfolio together for you because stock markets around the globe have lost between
lost over 5% in January 2016 have been very volatile this year and people are losing their minds. This is purely hypothetical.
How the sausage is made:
We want something that will "lose less" in a recession or steep correction.
We know that stocks are going to suck wind in a recession.
We know that high quality bonds should hold up in a recession.
There's the typical rule of thumb that you should "buy your age in bonds." As a refresher, that means if you're thirty, you could have 30% of your money in bond funds and 70% in stock funds.
If we're building an oh$hit portfolio, 70% in stock funds sounds like a lot. Don't worry. There are ways we can invest in stock funds, with lower risk.
Back to the bond fund exposure. That rule works best when interest rates are at normal levels. Right now they're very low. When you buy bonds, you give a loan to say, a company, and collect interest. If interest rates increase, and you're still invested in a bond that pays lower interest, your bond is now worth less. That's why when interest rates increase (decrease), the value of bonds decrease (increase).
The yield on a 10-year U.S. government bond is
about 2% is 2.45%.
The average historical interest rate is closer to 4%. You can see where I'm going with this. But maybe not.
We don't want as much bond exposure as the "buy your age in bonds" formula suggests because interest rates are at historical lows.
So back to our oh$hit portfolio, assuming you're 30 years old, let's chop that 30% bond allocation in half to 15% and put the other 15% in cash.
So now we have 70% in stock funds, 15% in bond funds, and 15% in cash for our #oh$hit portfolio.
We're using Vanguard Short-Term Bond Index ETF (BSV). This is a bond fund that invests in bonds that are very short-term (three years or less usually). That means that your interest rate risk is lower. Interest rate risk is the thing we talked about above: when interest rates go up, the value of your bonds you currently own go down.
Ok so 15% in BSV.
What stock funds? Well we like to make things as easy as possible so we're picking one fund: USMV iShares MSCI USA minimum volatility ETF as an example.
USMV is a low(er) volatility stock fund. That means it should lose less in a recession but also make less if the stock market increases in value by a lot.
Drumroll.....our oh$hit portfolio consists of:
70% in iShares MSCI USA minimum volatility ETF, USMV.
15% in Vanguard Short-Term Bond Index ETF, BSV.
15% in cash (I'm going to assume this is in a savings account at a bank earning zero interest).
Now let's calculate our "backtested" portfolio for the month of January (backtested just means we use historical performance to create a portfolio. We create the portfolio based on what we know already happened, so it's a bit of a sham). I am using a random month, in this case January 2016 so you understand how people calculate backtested performance.
USMV returned -1.4% in January 2016. With a 70% weighting in our oh$hit portfolio, that means that fund would've contributed (detracted) -0.98% in January.
BSV returned 0.79% in January 2016. With a 15% weighting in our oh$hit portfolio, that means that fund would have contributed 0.12% in January.
Cash, at your bank, delivered you 0%.
If we add those up, your oh$hit portfolio would have lost -0.86% in January 2016. That's less than one-percent.
Remember the S&P 500 lost 5% in January 2016.