Your Ideal Portfolio for Now

02/28/2008 12:00 am EST

Focus: STOCKS

Howard Gold

Founder & President, GoldenEgg Investing

"Nobody knows anything."

That's what the legendary screenwriter William Goldman once said about Hollywood. But the Oscar-winning writer of "All the President's Men" and "Butch Cassidy and the Sundance Kid" could have been talking about today's markets, too.

This may be the most confusing market in living memory. As fears of recession mount, commodities prices soar. Meanwhile, housing prices keep falling and the big Wall Street banks are almost certain to take more write-downs although no one knows where or when.

The risks are stark but contradictory-recession vs. runaway inflation. Or maybe both.

Right now, the biggest risk is of a real recession, which is why Ben Bernanke and the Federal Reserve are shoveling the charcoal to keep the fire burning. They have slashed short-term interest rates by more than 200 basis points since last September, and more cuts are likely. The $168-billion stimulus package signed by President Bush will put rebate checks of $300 to $1200 in Americans' pockets.

The economy will need all the fuel it can get. January's index of leading economic indicators fell for the fourth consecutive month as building permits, manufacturers' new orders, and capital goods all declined. Meanwhile, jobless claims are growing while consumer confidence has dropped like a stone. All not good.

Meanwhile, investors and speculators are pouring money into red-hot commodities markets. Crude oil has topped $100 a barrel, gold is quickly approaching $1,000 an ounce and wheat has hit $24 a bushel, up roughly eightfold from its price four years ago. 

This is setting off inflationary alarm bells, and indeed the key core inflation index (which doesn't include food and energy) jumped a hefty 0.3% last month. That's very troubling in light of the weak economy.

But the kind of nightmare low-growth, high-inflation environment we experienced in the 1970s is not in the cards, the Fed chairman told the Senate Banking Committee Thursday. "I don't anticipate stagflation," Bernanke said. So, don't take that white disco suit out of mothballs just yet.

What's an investor to do amid all this? Do you protect your assets against the ravages of inflation or batten down the hatches for a deflationary spiral? Is it time to be cautious or to follow Louis Navellier when he "dove into the market and bought with both hands"?

There are strong arguments on both sides, if you read the top independent advisers whose commentary we feature in Top Pros' Top Picks and Gurus' Views and Strategies.

These are all very smart people, some with stellar long-term track records. They're all passionate and persuasive-and they all disagree. For every Navellier who's buying aggressively, there's a Gary Shilling who says a severe recession is coming and it's time to buy bonds. (So does Charles Githler in a recent commentary on MoneyShow.com.)

So, to whom should you listen?

People who've read this column know that I've been bullish and I'm standing my ground. But at times like this, you and I need to protect ourselves against many different kinds of risks while also preparing to profit if things work out, as they usually do.

And yes, it can be done. I've set up a theoretical portfolio using only five exchange traded funds (ETFs) and one money market fund that should give you ample diversification and protection at the lowest possible cost, while still allowing you to profit from a new bull market. It assumes that you have ten years until retirement (give or take a few), are in good health, and are slightly more risk-tolerant than average, albeit not reckless.

You don't need a million dollars to assemble this portfolio; maybe even $10,000 will do. It ignores issues like taxes and estate planning, and assumes you have an account at a major discount broker. 

ETF Ticker Type of Assets % of Total Comments Expense Ratio
Stocks
Vanguard Total Stock Market VIPERs VTI Tracks Wilshire 5000, broad US index 30% 70% large cap, 30% small and mid cap 0.07%
Vanguard FTSE All-World Ex-US VEU Tracks broad international index 20% Includes Canada; almost 20% emerging markets 0.25%
iShares Russell 1000 Growth Index* IWF Tracks Russell 1000 growth companies 10% Good if you like large-cap growth stocks 0.20%
Bonds
Vanguard Total Bond Market ETF BND Tracks Lehman US Aggregate Bond index 20% Among broadest bond index funds--3,000 issues 0.09%
Commodities
iPath Dow Jones-AIG Commodity Index DJP Tracks broad commodities futures index 10% 1/3 energy, 1/3 metals, 1/3 agricultural 0.75%
Cash
Money Market Fund     10%   0.40%
Total     100%   0.224%
*Your choice, based on what you like now
**Blended rate based on weight in portfolio

So, let's start with stocks.

Based on your age, you need a hefty portion of your portfolio in stocks, at least 50%, probably 60%. I'd put 30% in the Vanguard Total Stock Market Vipers (AMEX: VTI), which tracks the Wilshire 5000, the broadest index of US markets. It includes large-, mid- and small-capitalization stocks, growth and value-everything.

Another 20% should go to the new Vanguard FTSE All-World Ex-US ETF (AMEX: VEU). It tracks the widest possible index of global stocks, including Canada and emerging markets, which the more popular MSCI EAFE index doesn't follow.

Emerging market stocks have been hit hard in recent months, and I do think the bloom is off the rose for that group. But at only 20% of this fund they represent less than 5% of your total portfolio, the amount I suggested last October when I recommended you lighten up on those high-flying markets. I don't expect international stocks to shine as they have over the past few years, but they should still represent about a third of your stock holdings.

I would also put 10% in the iShares Russell 1000 Growth Index (NYSEArca: IWF) which follows the large growth stocks in the Russell 1000-a sector of the market I have liked for the past last year. I'll get back to that later.

Another 20% should go into bonds, through the broadly diversified Vanguard Total Bond ETF  (AMEX: BND). Fixed income does well in recessions, and this ETF has one of the widest selection of bonds available.

I would also put 10% into the iPath Dow Jones-AIG Commodity Index Total Return ETN (NYSEArca: DJP), which buys commodity futures. Recent academic research shows that commodity futures can actually lower the overall risk in your portfolio. They're also, as we know, a great hedge against inflation and the continued weakness of the dollar (although they've certainly had a great run lately, so I wouldn't go overboard). The remaining 10% of the portfolio should go in a money market fund.

As for the 10% I put into the Growth ETF, consider it your discretionary money. If you expect recession, put more into bonds. If you anticipate runaway inflation, put more into commodities. If you like small caps, technology, emerging markets, or value stocks, put more into those sectors. If you see an individual stock you like, you can buy that.

(I would still avoid financial stocks, high-yield bonds, and real estate investment trusts, however, which remain exposed to the continuing credit crunch and financial crisis.)

But besides that, I'd pretty much stick to this portfolio, which gives you a good framework for making investment decisions at a time when it seems nobody-and I mean nobody-knows anything.

Howard R. Gold is executive editor of MoneyShow.com. At the time this was published he had positions in the Vanguard FTSE All-World ex-US ETF and the iPath Dow Jones-AIG Commodity Index Total Return ETN. The opinions expressed here are his own and do not necessarily reflect the views of InterShow.

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