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The Perfect Portfolio Does Not Exist

NEW YORK (TheStreet) -- Investors of all experience levels are interested in a Holy Grail portfolio that needs no attention, succeeds in most market environments and grows to be sufficient for retirement. To that point, last week I wrote about a risk parity-lite portfolio and over the weekend the Wall Street Journal had an article titled In Search of the Perfect Portfolio.

The reality is there is no ideal portfolio, no simple portfolio that will grow to the sky with no work required. However portfolios can be constructed that are simple, rules based and that won't turn into a full time job to maintain.

Where simple is a primary objective, investors can consider broad based index funds. Even with broad based funds investors can make things very complicated by using large, mid and small cap funds. They sometimes further slice the exposure into growth and value. One theme that gained a lot of traction in 2013 was so called smart beta which weights an index by some sort of factor like low volatility, revenue or several other fundamental factors.

There is little to no need to own more than one or two domestic broad based funds. The other day we looked at the iShares Russell 2000 Value Fund (IWN). Small cap value has a tendency to outperform large cap over long periods of time due in part to being slightly more volatile but it correlates very closely to large cap. ETFReplay.com reports that IWN has a 0.88 correlation to the SPDR S&P 500 (SPY).

The iShares S&P 400 Mid Cap Growth Fund (IJK) has a 0.92 correlation to SPY and a 0.91 correlation to IWN. The correlations are also high when looking at most of the smart beta ETFs too. Any of these funds might outperform for a short or long period of time but there is not much extra diversification benefit to owning six domestic funds that all have close to 0.90 correlations with each other.

Whatever you choose, know there will be times where that fund does relatively poorly. This year low volatility funds have lagged far behind SPY and IWN. The next time there is a bear market SPY and IWN will lag far behind the low volatility funds.

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