An annual survey by Pensions & Investments and Towers Watson & Co. (TW) looks at the world’s 300 largest retirement plans. In early September, P&I revealed that the assets of these plans grew by 9.8% in 2012, the fourth consecutive year of gains.
So what do these plans look like? Well, the top 20 plans — which account for 39% of the top 300’s $14 trillion in total global assets — invested 40% in equities in 2012, another 40% in fixed income and the remaining 20% in alternatives and cash.
If this asset allocation is good enough for the world’s biggest retirement plans, it should be good enough for the average investor. And you can build such a retirement portfolio using just a few exchange-traded funds:
First, let’s focus on the largest retirement fund in America — the Thrift Savings Plan, a defined contribution plan for federal employees. Plan holders have a choice of five individual funds — two that would be considered fixed income and three that are equity — that can be invested independently or within a target-date fund ranging in need from today through 2050.
The three equity funds track the S&P 500, the Dow Jones U.S. Completion Total Stock Market Index and the MSCI EAFE Index.
S&P 500 Exposure — Vanguard S&P 500 ETF (VOO): When it comes to the S&P 500, there are three standard choices: the SPDR S&P 500 ETF (SPY), iShares Core S&P 500 ETF (IVV) and the Vanguard ETF, the VOO. With little difference between the three, I’ll go with the VOO because it has the cheapest expense ratio at 0.05% annually.
Dow Jones U.S. Completion Total Stock Market Index Exposure — Vanguard Extended Market ETF (VXF): The Completion index represents all U.S. equities with readily available prices — excluding the S&P 500 — for a total of 3,136 stocks. Unfortunately, no ETF tracks this index, but again, a Vanguard ETF fits the bill. The Vanguard Extended Market ETF tracks the S&P Completion Index, which is essentially the same thing. VXF’s median market cap is $3.3 billion, putting it nicely in the mid-cap category. In business since December 2001, VXF’s total net assets are $2.4 billion and its expense ratio is a very reasonable 0.14%.
MSCI EAFE Index Exposure — db X-trackers MSCI EAFE Hedged Equity Fund (DBEF): The final piece of the equity puzzle is to select an ETF that replicates the MSCI EAFE Index, a group of 909 mid- and large-cap stocks from 22 developed markets excluding Canada and the U.S. The U.K. and Japan combined account for almost 44% of the index’s composition, and the median market cap is $6 billion — significantly larger than S&P Completion Index, but much smaller than the S&P 500.
To mitigate currency risk, I’ve chosen the db X-trackers MSCI EAFE Hedged Equity Fund, a hedged version of the index. DBEF holds 594 stocks and charges 0.35% annually, which is more than reasonable given the hedging activity. Year-to-date through Oct. 7, the fund has achieved a total return of 17.1% — 178 basis points greater than the index itself. However, it’s important to remember that when the U.S. dollar depreciates (it has appreciated in 2013 against major currencies), DBEF’s performance will trail the index. I’ve chosen this ETF to even out performance over the long-term.
Now, let’s move on to fixed income.