We employ actively managed mutual funds and a stock-heavy portfolio mix.
By Christine Benz | 01-27-17 | 05:00 AM | Email Article

Note: This article is part of Morningstar's Guide to Saving for Retirement. An earlier version of this article appeared on July 29, 2016.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

"I'm 15 years from retirement. Should I be splitting my portfolio into buckets?" 

I've received several variations of that question in response to my model bucket portfolios. My answer, in short, is that the bucket approach--essentially segmenting a portfolio by time horizon--is most useful for retirement planning. Not only does an in-retirement bucket portfolio provide ready cash reserves if the long-term components of the portfolio are at a low ebb (and, therefore, not good candidates for selling) but in better market environments, it also facilitates easy rebalancing to shake off income for living expenses. By contrast, a bucketed portfolio will tend to be less useful for accumulators, who are relying on their salaries, rather than their portfolios, to meet their day-to-day cash needs. 

That said, time-horizon considerations should be a key aspect of portfolio planning for accumulators, too. Given that the S&P 500 has had a positive return in rolling 10-year periods 95% of the time, people who won't need to tap their portfolios for another decade can reasonably steer the majority of their portfolios into stocks. Of target-date funds geared toward people retiring in the year 2025, for example, the average equity allocation is about 70%. The typical equity allocation among target-date funds geared toward 2055 retirees is roughly 90%. 

In addition to tilting their portfolios heavily toward stocks, people with many years until retirement can also reasonably hold more in potentially more volatile subasset classes, such as small-cap stocks and foreign stocks and bonds, than individuals with shorter time horizons. With less concern for short-term portfolio gyrations, they can benefit from the extra diversification and potentially higher returns that these subasset classes can provide. (This article discusses how subasset-class exposures should become more conservative as you get closer to retirement.) 

Saver Portfolios for Varying Time Horizons, Management Preferences
With those considerations in mind, I've created a series of model portfolios geared toward still-working people who are building up their retirement nest eggs. I've used Morningstar's Lifetime Allocation Indexes to inform the portfolios' asset allocations and the exposures to subasset classes. To populate the portfolios, I employed no-load, open funds that received Medalist ratings from Morningstar's analyst team. Most of the funds earned Gold ratings, though I've used Silver- and Bronze-rated funds in cases when suitable Gold-rated, no-load options that are accepting new investments are unavailable. 

Portfolio Basics
The Aggressive Retirement Saver mutual fund portfolio's weightings are as follows:
20%:  Primecap Odyssey Growth
20%:  Oakmark Fund
15%: Vanguard Extended Market Index
30%: Vanguard Total International Stock Index
7%:  T. Rowe Price International Discovery
3%:  Metropolitan West Total Return Bond
5%:  Harbor Commodity Real Return  

The Aggressive Retirement Saver mutual fund portfolio uses the allocations of Morningstar's Lifetime Allocation 2055 Aggressive Index to guide its weightings. That index devotes more than 90% of its assets to stocks, meaning that anyone considering such a portfolio should not only have a long time horizon but should also be able to tolerate the volatility that can accompany a very high equity allocation. 

That said, such a portfolio could also make sense for investors with shorter time horizons until retirement but ample income coverage in retirement. For example, the person who intends to retire in 2020 with in-retirement income needs covered entirely by a pension might reasonably consider a similarly aggressive asset allocation. 

Rather than employing separate holdings for large-cap value, blend, and growth stocks, the portfolio employs two large-cap holdings: Oakmark Fund, which employs a value-leaning strategy but lands in Morningstar's large-blend category, and Primecap Odyssey Growth for growth exposure. 

The portfolio tilts more heavily toward small- and mid-cap stocks than is the case with a broad market index fund. (The original version of this portfolio included a position in  Diamond Hill Small-Mid Cap , but that fund has since closed to new investors; I replaced it with Vanguard Extended Market Index.) It also stakes more than a third of equity assets in foreign-stock funds: a broadly diversified large-cap offering as well as one devoted to small- and mid-caps overseas, T. Rowe Price International Discovery. Both offerings include a sizable complement of emerging-markets equities. 

Due to all of these characteristics--a slight tilt toward small- and mid-caps and a large foreign- and emerging-markets weighting--the portfolio has an aggressive cast. As such, I would expect it to perform better than the broad market during strong equity environments and worse on the downside. 

How to Use
As with the bucket in-retirement portfolios, my key goal here is to depict sound asset-allocation and portfolio-management principles rather than to shoot out the lights with performance. That means that investors with very long time horizons and/or very high risk capacities could use it to help size up their own portfolios' asset allocations and sub-allocations. Alternatively, investors can use the portfolio as a source of ideas in building out their own portfolios. As with the bucket portfolios, I'll employ a strategic (that is, long-term and hands-off) approach to asset allocation; I'll make changes to the holdings only when individual holdings encounter fundamental problems or changes. 

Nearly all portfolios for investors in accumulation mode will be stock-heavy, because longer time horizons mean these investors have time to ride out bad markets. This aggressive portfolio will be especially sensitive to stock market movements. It may likely lose more than the broad market in sell-offs. Investors need to be prepared to stick with it in those tough times or risk losing the longer-term benefits.

I developed the portfolios with open architecture in mind--that is, I assumed that an investor wouldn't mind buying holdings from separate firms. But because all of the holdings shown here are mainstream in their exposures, investors who would like to stick with a single provider or supermarket could likely find funds with similar characteristics at their own firms. I've created fund-family-specific portfolios for Vanguard, Fidelity, T. Rowe Price, and Schwab supermarket investors. 

I also developed the portfolios without consideration for tax efficiency--that is, I assumed they would be held inside of a tax-sheltered wrapper of some kind, such as an IRA. Investors who intend to hold their portfolios inside of a taxable account would want to put a greater emphasis on tax efficiency, emphasizing index funds and ETFs on the equity side, for example. My Tax-Efficient Retirement Saver Portfolios are geared toward accumulators in taxable accounts.

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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