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2.Equally weight the ingredients
3.Rebalance periodically Each of the 12 mutual funds in the 7Twelve portfolio is assigned an equal allocation of 8.33%. The 7Twelve portfolio includes eight equity-based mutual funds that create an overall equity (stock) allocation of approximately 65% equity (66.6% to be exact). Four fixed income funds create a total fixed income (bond) allocation of about 35% (33.3% to be precise). With a 65% equity/35% fixed income asset allocation model, the 7Twelve can be categorized as a "balanced" portfolio because it has an overall asset allocation model that conforms to the general 60% stock/40% bond template. However, the 7Twelve portfolio is much more diversified than the typical 60/40 balanced portfolio. The 7Twelve design and asset allocation model does not change based on market conditions. The performance of the 7Twelve is, of course, affected by the performance of its 12 underlying investments, but the recipe does not change based upon the behavior of investment markets. Some people refer to this type of portfolio design as a "passive" approach. It rewards investors who exercise patience in following the recipe and who do not attempt to "overmanage" the portfolio. > > Bull or Bear? Vote in Our Poll Investment portfolios that are actively changing based on market conditions are referred to as tactical portfolios. Tactical portfolios ultimately rely upon the skill of the portfolio manager to react appropriately to changing market conditions. A tactical portfolio would, for example, be much less likely to equally weight the ingredients of the portfolio. Moreover, a tactical portfolio will tend to overweight or underweight various portfolio components at the discretion of the portfolio manager. If the manager is correct, the portfolio wins. If wrong, the portfolio loses. It's all based on skill, and skill is actually very hard to find. Tactical portfolios are referred to as an "active" portfolio management paradigm.
A Recipe That Goes Waaay BackThe origins of the 7Twelve recipe began years ago. Like most recipes, it was refined over a period of time. The 7Twelve portfolio is the indirect result of more than 20 years of mutual fund research and analysis. I say "indirect" because I never set out to design a multiasset portfolio. In the process of writing an article for the Journal of Indexes in 2007, I gathered and studied long-run performance data for seven major investment categories, or "asset classes." The seven major asset classes included in my original study were U.S. large-cap stock, U.S. small-cap stock, non-U.S. stock, U.S. real estate, commodities, U.S. bonds and U.S. cash. The historical performance data began in 1970. This seven-asset portfolio was the forerunner to what is now known as the 7Twelve portfolio. The seven-asset portfolio represents a subset of the 7Twelve portfolio.
2.Equally weight the ingredients
3.Rebalance each ingredient systematically The results were stunning. An equally weighted seven-asset portfolio provided excellent performance with substantially reduced risk compared to the performance of the individual ingredients (or assets) or in comparison to less diversified portfolios over a period of nearly 40 years. The best news is that the superior risk-adjusted performance was not the result of any special skill. Rather, it was produced by assembling a broadly diversifed portfolio and assigning equal allocations to all the ingredients -- and then rebalancing at systematic intervals. Some have referred to this type of portfolio design as naïve. I take that as a compliment. A naïve portfolio is one that acknowledges at the outset that transparent rules, rather than special skills, drive the results of the portfolio. But there is another important aspect of a simple, rules-based portfolio design -- namely, the issue of performance back-testing.
Getting Better and BetterThe fundamental principles from my seven-asset portfolio research in the fall of 2007 have now evolved into the 7Twelve portfolio: a multiasset portfolio that represents seven core asset classes but that is implemented by utilizing 12 underlying mutual funds. Again, the original seven asset classes from my 2007 model were U.S. large-cap stock, U.S. small-cap stock, non-U.S. stock, real estate, commodities, bonds, and cash. These seven were chosen because performance data back to 1970 was available. The 7Twelve portfolio represents an evolution of my original seven-asset model. It also utilizes seven core asset categories, but with several modifications. The seven core asset categories in the 7Twelve portfolio are U.S. stock, non-U.S. stock, real estate, resources, U.S. bonds, non-U.S. bonds, and cash. In the U.S. stock asset category, there are three underlying funds: large-cap U.S. stock, midcap U.S. stock, and small-cap U.S. stock. In the non-U.S. stock asset category, there are two underlying funds: developed non-U.S. stock and emerging non-U.S. stock. There is one underlying fund in the real estate category. There are two underlying funds in the resources asset class: natural resources and commodities. The 7Twelve portfolio has three fixed income asset classes: U.S. bonds, non-U.S. bonds, and cash. In the U.S. bonds asset classes, there are two underlying funds: U.S. aggregate bonds and inflation-protected bonds. The asset class of non-U.S. bonds has one underlying fund, as does the cash asset class. The 7Twelve portfolio made its debut in the summer of 2008. Its design was not a reaction to the gyrations of the investment markets in 2008 because it was designed in late 2007. As a strategic portfolio, the 7Twelve does not change with the wind. Rather, it employs 12 sails to catch a variety of winds. The 7Twelve portfolio can be the foundation of a preretirement accumulation portfolio or the core holding in a post-retirement distribution portfolio. The 7Twelve can represent your entire portfolio, or it can be a major component within a larger portfolio. However it is utilized, the 7Twelve design represents a fully diversified multiasset balanced portfolio. The word "balanced" is an established term that implies a mixture of stocks and bonds.
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