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This investment mix beats the S&P 500 — by a mile

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This article is the core of my best advice for long-term investors. If you want the very best equity portfolio, you’re about to learn what it is and how to put it together.

This article has three parts. The first is what might be called an “executive summary” of key points. The second outlines the step-by-step process of creating my recommended portfolio. The third digs deeper into a few related topics.

This is one of a series of articles I’ve written and updated annually for many years. Together, they outline a lifetime wealth accumulation strategy for do-it-yourself investors.

The other articles will tackle how to accumulate investment savings, how much to hold in bonds, and how to plan retirement withdrawals.

Part one

“Ultimate” isn’t a term to toss around lightly. But in the case of the ultimate buy-and-hold strategy, it fits. I believe this is the absolute best way for most investors to achieve long-term growth in the stock markets.

This strategy is based on the best academic research I can find — and it is the basis of most of my own investments.

Here are some key takeaways:

Because nobody can know the future of investment returns, massive diversification gives investors the highest probability for long-term success.

Most investors rely almost exclusively on the S&P 500
SPX,
-0.48%
.
But by adding equal portions of nine other equity asset classes, long-term investors can double or even triple their returns.

The additional return comes primarily from taking advantage of long-term favorable returns of value stocks and small-cap stocks. Taking this step involves only minimal additional risk.

The ultimate buy-and-hold portfolio works best for investors who don’t want or try to predict the future, time the market’s inevitable swings or pick individual stocks.

By investing in passively managed index funds or exchange-traded funds, this strategy offers investors a convenient, low-cost way to own thousands of stocks.

Read: Will Social Security still be there if I wait to claim it?

Part two

This “ultimate” all-equity portfolio automatically takes advantage of stock-market opportunities wherever they are.

It’s best to roll this out in steps so you can see how it goes together. To help you follow along, here’s a table showing the components.

The base “ingredient” in this portfolio is the S&P 500, which is a good investment by itself. For the past 51 calendar years, from 1970 through 2020, the S&P 500 compounded at 10.7%. An initial investment of $100,000 in 1970 would have grown to nearly $18 million by the end of 2020. Keep that figure in mind as a benchmark to see the results of the diversification I’m about to describe.

For the sake of our discussion, think of the S&P 500 index as Portfolio 1.

The next step involves shifting 10% of your portfolio from the S&P 500 to large-cap value stocks, which are regarded as relatively underpriced (hence the term value).

This results in Portfolio 2, which is still 90% in the S&P 500. Assuming annual rebalancing (an assumption that applies throughout this discussion), the 51-year compound return rises from 10.7% to 10.9%. That would turn $100,000 investment in 1970 into $19.4 million.

In dollars, this simple step adds nearly 15 times the amount of your entire original investment of $100,000 — the result of changing only one-tenth of the portfolio. If that’s not enough to convince you of the power of diversification, keep reading.

Read: We want to scale back to an up-and-coming town out West where we can retire — where should we go?

In Portfolio 3, we move another 10% into U.S. small-cap blend stocks, decreasing the weight of the S&P 500 to 80%.

This boosts the 51-year compound return to 11%; an initial $100,000 investment would grow to $20.7 million — an increase of nearly $2.8 million from Portfolio 1.

To create Portfolio 4, we move 10% of the portfolio into U.S. small-cap value stocks, reducing the weight of the S&P 500 to 70%. Small-cap value stocks historically have been the most productive of all major U.S. asset classes, and they boost the compound return to 11.4%, enough to turn that initial $100,000 investment into $24.4 million — with more than two-thirds of the portfolio still in the S&P 500.

Read: Is COVID-19 a preview of what retirement will be like?

To continue diversifying, we create Portfolio 5 by shifting another 10% into U.S. REITs funds. Result: a compound return of 11.4% and an ending cash value of just under $25 million.

I understand that many investors are uncomfortable with international equities. But I believe any portfolio worth being described as “ultimate” must venture beyond the U.S. borders.

Accordingly, to create Portfolio 6, we shift another 40% of the portfolio to four more important asset classes: international large-cap blend stocks, international large-cap value stocks, international small-cap blend stocks and international small-cap value stocks.

This reduces the influence of the S&P 500 to 20%. The result is a compound return of 12% and a 51-year portfolio value of $32.4 million — an increase of 81% over the S&P 500 by itself.

The final step, Portfolio 7, comes from adding 10% in emerging markets stocks, representing countries with expanding economies and prospects for rapid growth.

This boosts the compound return to 12.4% and a final value of $34.4 million.

This massively diversified 10-part portfolio is as far removed as possible from any effort to predict the future. Over 51 calendar years, it met all the asset-class predictions of academic researchers—and more than doubled the dollar return of the S&P 500.

Here are my specific recommendations:

Asset class

Recommended ETF (ticker)

Standard & Poor’s 500 Index

AVUS

U.S. large-cap value

RPV

U.S. small-cap blend

IJR

U.S. small-cap value

AVUV

U.S. real-estate investment trusts

VNQ

International large blend

AVDE

International large-cap value

EFV

International small-cap blend

FNDC

International small-cap value

AVDV

Emerging markets

AVEM

Unfortunately, this portfolio has an important drawback: It requires owning and periodically rebalancing 10 component parts. Relatively few investors have the time or inclination to do that.

Fortunately, we have devised a four-fund alternative that’s much easier to implement.

Since 1970, this “lite” version of the ultimate buy and hold strategy would have produced virtually the same compound return, dollar return and standard deviation as the 10-fund portfolio I outlined above.

In an upcoming article, I’ll roll out this new version.

Part three

It won’t surprise you to learn that there’s much more to say about this portfolio.

In 2020, we recalculated results from the 1970s to reflect new data we did not have in previous years. We also changed our assumptions about fund expenses that investors would have been charge in the 1970s. We believe our recalculations will better reflect what 21st century investors can reasonably expect.

Yet even after all these calculations, the returns did not change materially, and there’s no change in my beliefs or recommendations.

This updated data is as good as I can make it.

To learn more about these changes as well as some other reasons I think so highly of this portfolio, I hope you’ll tune in to my latest podcast.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.



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These money and investing tips can help you stay upright against the market’s headwinds

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Don’t miss these top money and investing features:

These money and investing stories, popular with MarketWatch readers over the past week, can give you greater knowledge about the financial markets’ current condition as you monitor your portfolio and plan ahead. Plus, check out several short videos about whether to include bitcoin and other cryptocurrency in your portfolio and how to go about it if you do.

Sign up here  to get MarketWatch’s best mutual funds and ETF stories emailed to you weekly!

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Opinion: I took advantage of the 2020 RMD rule but now my 1099-R looks wrong — what should I do?

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Q: I took advantage of the 2020 RMD rule and returned what I had taken from my IRA thinking there would be no taxes. I just got a 1099-R showing the full RMD. That can’t be right. How do I correct it?

—Pauline

A.: Pauline,

If the 1099-R is incorrect, you will need to contact the firm that issued the statement to get it corrected. However, the 1099-R is probably correct.

Read: Are there new RMD rules this year?

Under the law, the firm issuing the 1099-R has no responsibility for reporting how much of a distribution is taxable. That responsibility rests on your shoulders as a taxpayer. The issuing firm need only report what was paid out of the IRA on 1099-R.

Not sure where to retire? Let us help you find the right spot

That does not mean you will pay any tax. Any funds returned to the IRA by Aug. 31, 2020 is considered a rollover and is not taxable. Normally, Required Minimum Distributions (RMD) are not eligible for rollover, but IRS guidance after enactment of the CARES Act that waived RMD for 2020 changed that. The guidance stated the normal 60-day time limit for rollovers would not apply and instead instituted a fixed deadline of Aug. 31, 2020 to return such distributions and avoid taxation.

Read: It’s not too late to save on your 2020 tax bill — here’s how

I get similar questions about 1099-Rs every year. The reporting of the gross distribution looks like an error but in most cases, it is correct and the person receiving it simply hasn’t learned how it is accounted for yet.

Here’s how the accounting typically works.

As with any gross amount reported on Form 1099-R, you declare the amount that is not taxable when you file your 2020 tax return. What I hear most tax preparers would do in your situation is put the gross distribution amount from 1099-R on line 4a as per the normal procedure. Then, they would place a zero in 4b of your Form 1040, and put a note on the return near those lines that it was “returned to the IRA under the CARES Act,” “CARES Act rollover,” “CARES Act,” or simply “Rollover.”

Read: These are the best new ideas in retirement

If you did not return all of distribution by the deadline, the portion that was not returned would be taxable. You would put that number on line 4b.

Read: 5 things to do if you inherit a Roth IRA

As I mentioned a moment ago, the discrepancy between the gross distribution reported and what should actually be taxable comes up in other situations. Three of the most common are other rollovers, Qualified Charitable Distributions (QCD), and distributions from accounts that had received after-tax contributions.

In all those cases, the reporting process looks like what I described above. You put the gross distribution on line 4a and the taxable portion on Line 4b. Then note why the numbers are different with “rollover,” “QCD,” or “See Form 8606” on the 1040. Form 8606 is the form used to determine the taxable amount of an IRA distribution when nondeductible contributions have been made to any of one’s IRA accounts.

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.

Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.



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Video: Why Mike Novogratz sees bitcoin reaching $500,000 by 2024

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Galaxy Digital’s Mike Novogratz explains the outlook for crypto as Coinbase goes public.





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