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Benchmark Portfolios
We have developed five benchmark portfolios that not only offer an excellent opportunity for individual investors with a long time horizon to develop a core investment strategy, but also help to appreciate the inherent trade-off between risk and reward in financial markets. These benchmark portfolios reflect time-tested investment principles of diversification among individual securities as well as across several asset classes.
Risk
At Agri-Invest we think of risk as the degree to which things in the short-run could turn out differently from our long-run expectations. This risk can be measured by the amount of volatility in the annual return that you could expect to experience through time. The focus of all we do at Agri-Invest is to ensure that we construct portfolios for our clients that achieve their goals and objectives while taking the minimum level of risk. Our benchmark portfolios provide some indication of the inherent trade-off between expected return in the long-run and volatility in the short-run from investing in assets that are traded in well-functioning markets.
Inflation and Historical Results
The primary goal of long-term investors is to increase wealth; it does no good to earn a return of 5% if the prices of things we want to buy go up by 6% due to inflation. To achieve the goal of building wealth a portfolio must earn returns that exceed any erosion in purchasing power due to inflation. We believe that capital market prices in the long run will do reasonably well at capturing the effect of inflation. Therefore, as long as we adjust historical results to take out past inflation we can use the past relationship between volatility of return (risk) and average return to describe what is reasonable to expect in the future. Keep in mind that we are seeking to describe how markets are expected to pay, in terms of return, for bearing risk. We can be reasonably assured that when we compare the actual long-run rate at which wealth was built (return) to what we expected, markets will have adjusted for inflation.
Benchmark Portfolios - The Spectrum of Expected Return and Risk
Expected Return - Expected return reflects an average annual growth in the value of your portfolio over a long investment horizon. Realizing this return in the short-term will be purely coincidental. The short-term return will fluctuate around this long-term average. The size of this fluctuation is the risk an investor must endure.
Risk - Risk is the amount of the fluctuation in annual return. The percentage that reflects the level of risk inherent in a particular investment strategy measures the range of possible returns in any give year.
The expected return and risk of each of our Benchmark Portfolios, based on actual results since December 31, 1970 are presented in the following table (All returns are after inflation):
| Benchmark Portfolio: |
Capital Preservation |
Conservative |
Moderate |
Aggressive |
All Equity |
| Expected Return: |
2.9% |
4.6% |
6.0% |
7.0% |
8.2% |
| Risk: |
4.3% |
7.5% |
10.5% |
13.1% |
16.8% |
One way to interpret these percentage measures of risk is as a range within which the actual short-term return will be realized. For example, consider the Capital Preservation portfolio. The expected real return from the portfolio is 2.9% with 4.3% risk. This risk measure means that you should plan on an actual annual return within 4.3% of the expected returns in two out of every three years and outside this range in one out of every three years. So, one out of every six years it is reasonable to expect a return greater than 7.2% and, by the same token, you can expect less than -1.4% with the same frequency. You can use a similar analysis to assess the risk and expected return trade-offs in each of the other Benchmark Portfolios.
Once again, the returns presented in the above table and in the chart below have been adjusted for inflation and reflect a rate at which real wealth can be built. We believe that over the long run financial markets adjust for actual inflation. Consequently, it would be reasonable to add whatever inflation was experienced to the above returns to determine the nominal rate at which the portfolio would be expected to grow, on average. For example, since December 31, 1970 inflation averaged about 4.7%. Thus, if you were to add 4.7% to each of the expected return numbers you would get what each of these benchmark portfolios in fact earned on average since December 31, 1970.
The following chart uses actual real results (net of inflation) since December 31, 1970 to show that the level of risk of each benchmark portfolio increases as the level of expected return increases.
Our Benchmark Portfolios
I. Capital Preservation - A strategy appropriate for investors with a short time horizon and/or a desire to maintain current wealth with little regard for growth
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Money market |
50% |
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Bond market |
40% |
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Large cap stock market |
10% |
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II. Conservative - A strategy appropriate for an investor who is somewhat interested in growth, but is especially worried about periodic fluctuations in the value of their portfolio
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Money market |
20% |
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Bond market |
50% |
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Large cap stock market |
20% |
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Small cap stock market |
5% |
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International equity market |
5% |
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III. Moderate - A strategy appropriate for investors who are keen on growth, yet are willing to give up some expected growth for a reduction in the periodic fluctuations in value
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Money market |
Minimum |
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Bond market |
50% |
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Large cap stock market |
30% |
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Small cap stock market |
10% |
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International equity market |
10% |
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IV. Aggressive - A strategy appropriate for investors with growth as the sole objective and are willing bear the corresponding periodic fluctuations in value
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Money market |
Minimum |
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Bond market |
30% |
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Large cap stock market |
40% |
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Small cap stock market |
15% |
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International equity market |
15% |
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V. All Equity - A strategy appropriate for investors with fixed income investments elsewhere. This portfolio is never appropriate for an investor's entire portfolio.
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Money market |
6% |
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Bond market |
Nil |
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Large cap stock market |
40% |
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Small cap stock market |
27% |
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International equity market |
27% |
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