Portfolio Construction

Putting it all together

Constructing the right portfolio is a delicate balance between risk and reward. At PIG, we construct our portfolios using a five factor model.

Five Factor Model

This five factor model incorporates the three factors discussed previously for stocks and two additional factors for bonds (quality and duration). The stock portions of our portfolios are designed to capture these return premiums in proportion to their historical magnitude as discussed in the Three Factor Model section of our website.

The bond portions of our portfolios are designed to capture stability of principle and income with an emphasis on stability of principle. While longer duration and lower quality bonds do offer some potential for increased yield, we believe the risk inside any portfolio is better spent in the equity portion where you get more excess return per unit of risk. It makes little sense to take risk with the portion of your portfolio that is supposed to provide stability. Unlike stocks, bonds offer little in excess return for additional risk. Therefore, we only use bonds that are high quality and short duration.

This disciplined approach gives us greater confidence in knowing what we own and what to expect based off of market performance. It removes the guesswork and black box formulas of most modern day managers.

While you can use the Five Factor Model to create an unlimited number of portfolios with differing risk/reward characteristics, only a handful are needed in the real world. We have created 10 globally diversified portfolios using low-cost, passively-managed funds to help cement our philosophy. Click here to see the historical returns of those portfolios. We currently use DFA funds from Dimensional Fund Advisors because they offer the best combination of low fees and construction precision compared to any other group.

We recommend you invest the money you need to satisfy your lifestyle in a globally diversified portfolio of 30% stocks and 70% bonds. The 30% stocks give you the edge needed to keep up with or slightly outpace inflation and the 70% bonds gives you the stability needed for retirement income and emotional comfort.

Once you have the amount of money you need invested in a 30/70 portfolio, you can invest your excess monies more aggressively. It is OK to reach for higher returns with your excess monies, but we do not think it is wise to do so with the money you know you need b/c the added uncertainty outweighs the potential benefit of higher returns. We believe the primary retirement goal should be to meet your objectives without running out of money. Introducing the possibility that you run out of money so you can say you had a higher average return seems illogical.

The majority of our clients use Portfolio 30 for the capital they need and either Portfolio 60, Portfolio 80, or Portfolio 100 for any excess funds they have depending on their risk tolerance and projected use of the excess money. Most use Portfolio 60.