This is part of an ongoing series evaluating the merits of popular static asset allocation portfolios. I had heard vaguely of this portfolio, and then had it recommended to me by my free financial planner, so I thought I'd take a look. It is used by a lot of Utah doctors partly because the author works at a university in this state, but mostly because it is recommended by the UMA financial “gurus.”
Craig Israelson has a PhD in Family Resource Management and teaches personal finance classes at Brigham Young University. He debuted the portfolio in 2008 and published the book in 2010. He has been published in all the major finance journals and can easily be considered an authority on the subject of portfolio design. Materials related to the portfolio are marketed on the 7Twelve website (no financial relationship to me.) Since BYU (and probably most) professors don't make much money, he is also a principal at Target Date Analytics where he also works evaluating mutual funds and their appropriateness for investors and their 401Ks.
7Twelve- The Book
The book itself is a typical “Boglehead” style book in which the merits of wide diversification, designing and implementing a multi-asset class portfolio, rebalancing, and staying the course are discussed. He uses a lot of cooking analogies as he builds the portfolio from a “recipe” as the book goes on. One part about the book that I particularly liked was his discussion about saving. I quote:
Contributions are largely controllable by the investor, while performance (particularly in the short run) is not. As a result, investors who rely upon the performance of their portfolio to do the “heavy lifting” (that is, to make up for their insufficient contributions) will usually fall into the trap of having too much equity exposure and therefore be exposed to too much risk….Why would otherwise rational individuals develop irrational performance expectations for their retirement portfolios?….
Relatively few retirees have saved enough…because many investors undersave and overspend, they tend to “need help” from their portfolios. Indeed, the phrase “need help” is a significant understatement. The blunt truth is that far too many investors expect their retirement portfolios to generate heroic performance that will save them from years of under-contributing to their retirement accounts. This misguided hope leads to portfolio allocations that are far too aggressive.
It has been said before, and I'll say it again, if you don't know how much to save for retirement you won't save enough. The amount you need to save is far more than most people intuitively think it is. 5% isn't going to cut it. Doctors need to be saving 20% of their income toward retirement. At any rate, the book is quite good. If you've read a dozen other books similar to it you won't learn much from it, but the timeless principles it espouses are always worth refreshing. I would have liked to see more emphasis on paying attention to investment and tax expenses, but that is a minor criticism of the book.
Now, let's get to the meat of the portfolio. Like any good static asset allocation portfolio, it is a strategic portfolio where you set the percentages and rebalance them when they get out of whack. You don't pay attention to market events except in the circumstances that they call for you to rebalance. Naturally, like any good idea, someone sees a way to make a buck with it by adding some marketing spin (and usually some market-timing.) Such is the case with this portfolio as can be seen with the Tactical 7Twelve Portfolio (which I don't recommend as I am always wary of a financial firm whose fees are not listed on their website.) There is even a mutual fund started last March NOT run by the author that follows the 7Twelve portfolio. It has a front load of 3.5% and an ER of 2.27%. How embarrassing for the author. 2.27% and a 3.5% load just to assemble 12 ETFs into one fund? How can anyone feel good about that? At any rate, this portfolio is best viewed graphically.
The writing is a bit small but basically the portfolio is composed of 7 different asset classes using 12 different funds or ETFs. Each fund gets 1/12th of the portfolio, or 8.3%. Rebalance as necessary. That's it.
The 7 asset classes are US Stocks, International Stocks, Real Estate, Commodities, US Bonds, International Bonds, and Cash. The US stocks get split by size, the international stocks get split by region (developed vs emerging), commodities get split into natural resources and commodities, and US Bonds are splint into nominal bond and TIPS which gives you your 12 slices. 7Twelve. Catchy isn't it.
No one has been using this portfolio for very long, and like any one who designs a portfolio, they've used back-testing to simulate performance. While interesting, it is important that you realize that using back-tested results to determine how to invest in the future is like using a case-control study to determine the effectiveness of a new drug. A prospective randomized controlled trial is the gold-standard in medicine for a reason. We certainly can't use the mutual fund to evaluate its performance due to its outrageous fees and short life (it started in March 2011), so we'll look at Israelsen's back-tested theoretical results:
From 1970 to 2010, an equally weighted portfolio of the 7 asset classes would have returned 10.52% per year (not counting investment expenses and fees), with a worst year of -27.59% (would it surprise you to know that was 2008, probably not). That's pretty good, similar to the Vanguard S&P 500 fund (with obviously better performance the last 10 years.) So returns similar to a 100% equity portfolio with only 50% equities. Will it hold going forward? Who knows. Recency bias can be a deadly thing.
More importantly, is it a reasonable portfolio? Absolutely. There are literally hundreds of good portfolios out there, and this is certainly one of them. The most important thing is that you pick one and stick with it, through thick and thin, throughout your investing career.
What don't I like about it? Several things. First, it has a pretty healthy dose of commodities in it. I'm not a big fan of commodities for both practical and theoretical reasons. He defines the natural resources slice as the companies that do the mining, refining, and transporting (think Vanguard's precious metals fund) and the commodities slice as the actual commodities through futures contracts. His recommended natural resources index is followed by an ETN (similar to an ETF but with some additional significant risks) with an ER of 0.75% with very light volume–a bit on the expensive side and somewhat illiquid. His recommended commodities index is followed by an ETF, but with an ER of 0.85%. Practically speaking, these funds are too expensive, too complex, and too illiquid and aren't ready for prime time yet. On a theoretical basis, I haven't yet been convinced of the merits of tilting a total market portfolio toward resource producing companies. I own all the stocks in the ETN for 1/10th the price through a total stock market fund. Do I really need more of them? Likewise, I'm not convinced of the merits of a collaterized commodities future fund. Long-term returns are similar to T-bills, so the argument has to be made based on correlations, and I don't quite buy it.
Second, a recommendation for foreign bonds is pretty new. No one was talking about them a few years ago. There didn't use to be any reasonable cost options. Vanguard came out with a lower cost fund (0.4% ER) this year for foreign bonds, but that is still four times the cost of domestic bonds. Cost matters even more with bonds than with stocks as Bogle decisively demonstrated. I'm just not convinced its a necessary asset class for a portfolio, especially at the usual price. But I suppose if the US credit rating keeps dropping perhaps diversifying away from the US would be a good idea! I suspect all the excitement on this topic is recency bias, since US bonds in particular have had such low yields the last few years.
Lastly, the portfolio is a bit schizophrenic about its equity tilts. The US portion tilts toward small, but the international portion does not. There is no built in value tilt, but he has an entire chapter in the book explaining why value stocks are better than growth stocks. Why not just a total market fund and a small value fund? Oh, because then it would be the 7Eleven portfolio, and that name is already taken. Seriously though, why incorporate the small tilt and not the value tilt. The data is better for the value tilt. And why only in the domestic market? Doesn't quite make sense. I have similar issues in my portfolio, but it is more for the practical reason of lack of low cost options in some asset classes.
Overall, the book and the portfolio are worth looking at. You can certainly do much, much worse. I'm grateful to Mr. Israelsen for advancing the good work of investor education.