FUND WATCH


Three Simple, Successful Portfolios

Bob Frick

In January, we asked the experts to recommend low-cost funds. Their portfolios have gained from 7% to 17% so far.



In January, Kiplinger's asked three experts to recommend simple mutual fund portfolios based primarily on low-cost index funds. We promised we'd update the portfolios at the six-month point, and true to our word, here are the results. Our simple portfolios fared from not bad to great.

The portfolio of Princeton professor Burton Malkiel, author of the investment classic A Random Walk Down Wall Street, led the way with a 17% return through June 30. By contrast, Standard & Poor's 500-stock index was flat in the first half.

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Emerging markets, up an average of 34% through June, gave Malkiel's portfolio a big lift. Most of his portfolio was composed of three relatively tame index funds -- low-cost mutual funds that seek to mimic a market benchmark, such as the S&P 500. But he had significant positions in Templeton Dragon, an actively managed closed-end fund that gained 36%, and Matthews India, a regular mutual fund that soared 47%. He picked the Dragon because at the time it was trading at a big discount to the value of its underlying assets, and he saw the Matthews fund as the best way to play India. "I believe that of all the places in the world, China and India are the two that will have the highest growth rates," Malkiel says.

He's sticking with those countries and with his portfolio. "I still think that emerging markets look very good," he says. China, he says, has already recovered from the collapse in exports and is growing again-perhaps at a 7% rate this year. He concedes that Chinese stocks may suffer a correction but says it's impossible to know when to jump in and out of markets, so investors need to learn to ride out the ups and downs.

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Note that Vanguard Emerging Markets ETF, an exchange-traded fund that tracks an index of developing-markets stocks, scored a 34% gain, proof that passive investing in emerging markets also excelled in the first half.

Malkiel's portfolio through June 30:

20% Vanguard Total Stock Market ETF (VTI) (Tracks a broad index of U.S. companies) -- 4.45% return through June 30
20% Vanguard FTSE All-World ex-US ETF (VEU) (Tracks a broad index of stocks from developed and emerging foreign markets.) -- 12.3%
20% Vanguard Total Bond Market ETF (BND) (Tracks a broad index of high-quality U.S. bonds) -- 2.09%
10% Vanguard Capital Opportunity (VHCOX) (An actively managed fund that likes big growth companies down on their luck) -- 17.49%
10% Vanguard Emerging Markets ETF (VWO) (Tracks an index of stocks developing nations) -- 34.34%
10% Templeton Dragon (TDF) (Invests in stocks from China and nearby nations) -- 36.14%
10% Matthew's India (MINDX) (Invests in stocks from India) -- 47.19%

Emerging-markets stocks also helped Larry Swedroe's portfolio. Swedroe, director of research for St. Louis-based Buckingham Asset Management and author of several useful books, including The Successful Investor Today and The Only Guide to a Winning Investment Strategy You'll Ever Need, put 4% of assets in the mutual fund version of Vanguard Emerging Markets, which jumped 34%. Also aiding his portfolio, which returned 7%, was a stake in iShares MSCI EAFE Small Cap Index, an ETF that tracks stocks of small, overseas companies.

Swedroe's portfolio reflects his commitment to overseas diversification: 30% of his portfolio is in foreign stocks. It also tilts toward value and small-company stocks-both of which, studies show, tend to outperform growth companies over time.

Swedroe's portfolio:

15% Vanguard Value Index (symbol VIVAX) (Tracks an index of undervalued stocks from the largest 750 U.S. companies) -- (-2.4% loss through June 30)
15% Vanguard Small Cap Value Index (VISVX) (Tracks an index of stocks of small, undervalued U.S. companies) -- 1.36%
13% iShares MSCI EAFE Value Index (EFV) (Tracks an index of stocks of large, undervalued foreign companies) -- 9.38%
13% iShares MSCI EAFE Small Cap Index (SCZ) (Tracks an index of stocks of small overseas companies) -- 20.75%
4% Vanguard Emerging Markets Stock Index (VEIEX) (Tracks an index of companies from developing nations) -- 34.23%
40% Vanguard Inflation-Protected Securities (VIPSX) (Invests at least 80% of assets in inflation-indexed bonds issued by the U.S. government) -- 5.51%

We asked our third expert, William Larkin, fixed-income portfolio manager at Cabot Money Management, in Salem, Mass., to provide a fixed income-only portfolio. It also returned about 7%. Larkin is the only expert who elected to change the investments in his portfolio. He thinks rising inflation-or fear of rising inflation-will lead to higher interest rates. That would particularly hurt the value of iShares Barclays Aggregate Bond ETF, which tracks a broad index of high-quality U.S. bonds.

Until the inflation threat passes, he's splitting the 25% stake he previously held in the Aggregate Bond fund between two ETFs with bonds of shorter maturities. His two new picks are iShares Barclays 1-3 Year Credit Bond (symbol CSJ) and iShares Barclays Intermediate Credit Bond (CIU). "I think there's going to be some real volatility and change in the bond market," Larkin says. "Now is the time to embed your portfolio with some protection."

Larkin's portfolio:

25% iShares Barclays Aggregate Bond ETF (AGG) (Tracks a broad index of high-quality U.S. bonds) -- 1.34% through June 30
25% iShares iboxx $ Investment Grade Corporate (LQD) (Tracks an index of the most liquid, long-term corporate bonds) -- 2.9%
10% Fidelity Floating Rate High Income (FFRHX) (Invests in floating rate bank loans that automatically adjusts to rising short-term interest rates. It offers additional inflation hedge) -- 19.31%
10% iShares MBS Fixed Income (MBB) (Tracks a broad index mortgage-backed securities) -- 2.25%
7.5% SPDR DB International Govt Inflation-Protected Bond (WIP) (Invests in an index of non-U.S., inflation-linked bonds) -- 9.71%
7.5% PowerShares Emerging Markets Sovereign Debt (PCY) (Tracks an index of emerging markets government debt) -- 18.63%
7.5% iShares Barclays TIPS Bond (TIP) (Tracks an index of inflation-protected, U.S. Treasury securities) -- 6.25%
7.5% iShares Iboxx $ High Yield Corporate Bond (HYG) (Tracks an index of high yield bonds) -- 18.6%

Full disclosure: We added our own picks to the simple portfolios story that appeared in the April issue of Kiplinger's Personal Finance magazine. Our package gained 5%, hurt by a lower allocation to emerging-markets stocks and an allotment to a real estate fund. But we're sticking to our guns. We expect the real estate market to come back eventually, and when it does, we believe our pick will deliver double-digit gains.

Investors have soured on real estate because the industry is in the tank. Many saw their real estate funds crash more than the overall stock market. However, I made money in real estate over the past six years simply by rebalancing my portfolio every six months -- returning investments to their original percentages.

Rebalancing is a simple way to help you sell high and buy low. It effectively forces you to sell better-performing funds and replace them with laggards. In the case of my real estate funds, I was gradually taking profits when real estate stocks were booming in the middle of the decade (the Vanguard REIT index fund, for example, was up 30% in 2003, 2004 and 2006). This strategy served me well during the bear market.

We rebalance all the simple portfolios to their original positions every six months. For the portfolios of Malkiel and Swedroe, that means lightening up on those red-hot emerging-markets funds and using the proceeds to buy U.S. stock funds.

Kiplinger's Portfolio

25% Vanguard 500 Index (VFINX) Tracks Standard & Poor's 500-stock index -- 3.21%
15% Vanguard Small-Cap (NAESX) Tracks an index of small-company U.S. stocks -- 7.35%
20% Vanguard Total International Stock (VGTSX) Tracks an index of stocks from developed and emerging nations -- 10.75%
5% Vanguard REIT (VGSIX) Tracks an index of U.S. real estate investment trusts -- (-11.69%)
25% Vanguard Total Bond Market Index (VBMFX) Tracks a broad index of high-quality U.S. bonds -- 2.11%
10% Vanguard Inflation-Protected Securities (VIPSX) Invests most assets in Treasury inflation-indexed bonds -- 5.51%




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