When you start to educate yourself about making money in the stock market, a common theme you’ll come across is the need for diversification.
The concept is based on the old adage “don’t put all your eggs in one basket.” In the stock market, you shouldn’t allocate 100% of your investment dollars into one asset because if the asset tanks, you’ll lose your shirt.
However, spreading your investing dollars over a long list of assets can be a daunting process. After all, it’s important to research every investment before risking your hard-earned money, which poses a bit of a problem.
What do people with little time or desire for research — or new investors who don’t know how — do when they want to invest?
The 7Twelve investment portfolio addresses that problem.
What Is the 7Twelve Portfolio?
The portfolio was developed by Craig L. Israelsen, who teaches as an executive-in-residence in the personal financial planning program at Utah Valley University.
Named for the portfolio’s allocation strategy, investors who use this multi-asset investment portfolio invest in 12 different funds across seven asset classes.
The portfolio is one of many models in a category known as lazy portfolios, which are designed to be set-it-and-forget-it investment options to the greatest degree possible.
This is one of the most diversified prebuilt portfolio options you’re going to find, offering a safety net should a single asset or an entire asset class within the portfolio take a dive.
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Portfolio Asset Allocation
At first glance, the portfolio may seem to be complex, but it’s actually very easy to set it up, as the 12 included assets all have an equal weight of 8.3%. Here’s what the portfolio invests in:
- 8.3% in U.S. Large-Cap Stocks. As with most portfolios designed by investment professionals in the United States, the prescription for this portfolio calls for allocation to large-cap U.S. stocks. The fund representing this allocation should be heavily diversified, investing in companies ranging in sectors as well as different styles of stocks.
- 8.3% in U.S. Mid-Cap Stocks. Another portion of the portfolio’s domestic stock investments goes to mid-cap stocks. As with their larger counterparts, the fund you choose to address this allocation should be well-diversified across various sectors and styles of stocks.
- 8.3% in U.S. Small-Cap Stocks. Small-cap U.S. stocks are the smallest companies in the portfolio, offering up the largest opportunities for long-run profitability. Again, diversification is key when choosing the investment-grade fund that gives you exposure to these assets.
- 8.3% in Developed-Market International Stocks. The portfolio calls for three international assets, with one of those being an international ETF that’s highly representative of the global stock market. It’s important that 100% of the holdings in the fund’s portfolio are non-U.S. stocks because domestic allocation is addressed with other investments. Moreover, the fund should offer exposure to a wide range of sectors and market caps in developed economies around the world.
- 8.3% in Emerging Markets Stocks. Another piece of the international exposure the portfolio calls for is emerging markets. These markets, like China, Brazil, and South Africa, haven’t yet made it to developed status but are growing quickly. The fund you choose should invest across multiple sectors within multiple emerging economies.
- 8.3% in Real Estate Investment Trusts (REITs). The 7Twelve strategy also exposes investors to the real estate market. The best way to do so is to invest in a real estate investment trust (REIT), a type of fund that’s centered in real property.
- 8.3% in Cash. Next up, the portfolio calls for investments in cash and cash equivalents, but you don’t need to stash a pile of money under your mattress. Instead, allocate these dollars to an exchange-traded fund (ETF) that’s focused on short-term Treasury debt securities, which offer a minimal return but hold their value similar to cash.
- 8.3% in U.S. Bonds. The 7Twelve Portfolio also includes domestic bonds. The strategy doesn’t provide specifics as to whether you should go with government or corporate bonds, but if you’re looking for added stability, government bonds are the better option, whereas corporate bonds will offer better returns but tend to be more volatile.
- 8.3% in International Bonds. The next piece of the safe-haven allocation is invested in international bonds. When buying an ETF to address this piece of the allocation, look for an ex-U.S. fund, meaning it only invests in non-U.S. bonds.
- 8.3% in Treasury Inflation-Protected Securities (TIPS). The portfolio calls for exposure to Treasury inflation-protected securities (TIPS) to provide stability. The fund you choose should provide diversified exposure to inflation-protected securities issued by the U.S. government.
- 8.3% in Commodities. The portfolio also calls for investments in commodities through a diversified investment-grade fund. The best funds will cover the hottest commodities in the energy, metals, and agricultural sectors.
- 8.3% in Natural Resources. Natural resources are climbing in value as well, and the portfolio makes sure to include them. These include resources like water, timber, and precious metals.
The Investment Thesis Behind the Portfolio
The 7Twelve strategy is one that provides access to the growth the market has to offer by maintaining a diversified portfolio across several asset categories. In doing so, the portfolio offers significant protection against volatility.
Like the Ray Dalio All Weather Portfolio and the Pinwheel Portfolio, it was designed to provide stable growth through all economic cycles:
- Inflation. When inflation takes place, the value of the U.S. dollar falls, meaning it costs more money to buy products. This economic cycle is addressed by investments in stocks, real assets, commodities, TIPS, and natural resources, all of which tend to rise in value when inflation sets in.
- Deflation. During times of deflation, prices are falling and corporate earnings take a hit, often leading to declining values in the stock market. The good news is that when these declines take place, you’ll be protected with this portfolio through investments in bonds and cash, all of which tend to rise in value when consumer prices fall.
- Economic Expansion. When the economy is expanding, consumers are spending, corporations are shoveling the profits in, and investors are smiling from ear to ear. During these times, stock market investments tend to experience their most pronounced upward movement. Real estate and commodities will also generally benefit from economic expansion.
- Economic Contraction. Economic contractions have the ability to wreak havoc on corporate profits, generally leading to bear markets. That’s not concerning to those who follow the 7Twelve strategy because the heavy allocation to safe havens within the portfolio acts as a source of protection.
As you can see, the diversified list of assets works well to the investor’s advantage. The assets in the 7Twelve Portfolio were thoughtfully chosen due to their negative correlations with one another. When one asset is falling in value, others pick up the slack, limiting the losses.
There is a downside to the strategy, however.
This is an incredibly safe portfolio, meaning that while you’ll enjoy stability, the potential returns on your investment will be significantly reduced as a result of heavy allocation to safe havens.
Nonetheless, if you’re looking for safe, slow, and steady growth in your portfolio, the 7Twelve strategy might just be the perfect fit.
Pros and Cons of the 7Twelve Portfolio
Any time you make a financial decision, it’s important to consider the pros and cons before diving in. When it comes to the 7Twelve strategy, the most important pros and cons to consider are as follows:
The 7Twelve strategy has become a popular one, which doesn’t happen unless there are clear benefits to investors. Some of the most exciting features of this portfolio include:
- Limited Drawdown Risk. Regardless of the state of the stock market, there are assets included in the portfolio that will generate profitability. As a result, even when significant drawdowns hit Wall Street like a hurricane, your portfolio will be protected.
- Even Allocation. While there are 12 different assets included in the portfolio, each asset is equally weighted. This adds a level of simplicity to the setup and management of the portfolio. Moreover, as a lazy portfolio, there won’t be much time required for management once you set it up.
- Heavy Diversification. Although you’ll only be making 12 investments, your investments will represent thousands of publicly traded companies, fixed-income securities, and commodities from all over the world. In fact, this is one of the most heavily diversified prebuilt portfolios on the market today, which helps to limit volatility.
Sure, there are plenty of reasons to be excited about the 7Twelve strategy, but it’s important to remember that no investment strategy is perfect. Like all others, there are some drawbacks that you should think about before diving into the portfolio.
- Slow Growth. Not only will you never beat the market using this portfolio strategy, your annualized returns likely will be significantly lower than benchmarks like the S&P 500, Nasdaq, and Dow Jones Industrial Average.
- Heavy Safe-Haven Allocation. Much of the portfolio’s assets are nestled in safe havens, which isn’t necessarily a bad thing for all. However, most investors are more risk-tolerant and don’t want half of their portfolio’s value excluded from the strong potential gains the stock market has to provide.
- The Inclusion of Cash. Cash is one of the most heavily debated assets in the investing community. Sure, it has its place, but many argue that this place is in a savings account, not an investment portfolio.
- Limited Factoring. While a small portion of the portfolio is allocated to emerging markets, which do pay risk premiums, with such a heavy allocation to safe havens, it would be advantageous to add in other assets that pay strong risk premiums to expand potential earnings, with small-cap stocks and value stocks being at the top of the list. Unfortunately, this portfolio doesn’t seem to take factoring into account.
Who Should Use the 7Twelve Portfolio?
The 7Twelve investment strategy isn’t a one-size-fits-all opportunity. This portfolio strategy suggests 50% of your assets should be held in safe havens, which makes it a very low-risk portfolio strategy. It’s not a good fit for young or middle-aged investors, nor those with a high risk tolerance.
The investor who would be the perfect fit for this strategy is:
Investors Nearing Retirement
As you get closer to retirement age, it’s important to take steps to limit drawdown risk. Considering the heavy safe-haven allocation, this is the perfect portfolio for someone who’s 15 or fewer years away from retirement, but not less than five years away.
This is a compelling model for investors who see the light at the end of the tunnel and want to begin to shift away from riskier assets, but for those already at or beyond retirement age, even this low-risk portfolio may not be conservative enough.
Although the safe havens included limit volatility, making it a perfect option for the later stages of retirement planning, half of the portfolio is still invested in equities, which come with a more substantial drawdown risk.
Focused on Medium-Term Goals
Even if you’re not nearing retirement, this portfolio may be a good fit, especially if you’re investing in an effort to reach medium-term goals.
For example, say you’re tired of renting and you’d like to buy a house within the next five to 10 years. In this case, the stock market could be a great way to go about boosting your savings.
Through this portfolio, your average annual returns will generally be around 5%, which is much higher than the interest paid on a savings account. At the same time, you won’t be accepting excessive risk that could eat into your savings and force you to wait longer to become a homeowner.
How to Duplicate the 7Twelve Portfolio
If you’ve decided the 7Twelve strategy is the route you’d like to take in the market, you’re in luck. Duplicating the portfolio is a simple process using index funds and ETFs.
Keep in mind that when taking advantage of investment-grade funds, you’ll want to pay close attention to expense ratios to make sure costs don’t eat up too much of your profits.
Also, there are two popular ways to go about mirroring this portfolio strategy. Either follow the traditional prescribed asset allocation or make a few small adjustments to bring factors that pay risk premiums into play, resulting in higher potential returns.
The Traditional Rendition
To follow the traditional portfolio allocation model, use the assets below:
- 8.3% in Vanguard S&P 500 ETF (VOO). The VOO fund addresses the large-cap allocation within the portfolio, investing in the 500 stocks listed on the S&P 500, which is an index that represents the 500 largest publicly traded companies in the United States.
- 8.3% in Vanguard Mid-Cap Index Fund ETF (VO). The VO fund offers diversified exposure to domestic stocks that trade within the mid-cap range. These stocks are heavily diversified in terms of sector and investing style, giving widespread exposure to medium-sized companies across the U.S.
- 8.3% in Vanguard Small-Cap Index Fund ETF (VB). Like the VOO and VO funds, VB invests in a heavily diversified portfolio of domestic stocks, with the difference being in the market cap. The stocks in this fund represent small companies with market capitalizations under $2 billion.
- 8.3% in Vanguard FTSE Developed Markets Index Fund ETF (VEA). The VEA fund is a diversified portfolio of international stocks, covering both developed and emerging markets outside the U.S. As an all-cap fund, it invests in companies of all sizes that operate in a wide range of sectors.
- 8.3% in Vanguard FTSE Emerging Markets Index Fund ETF (VWO). VWO is one of the leading emerging markets funds on the market today, investing in stocks in China, Taiwan, Brazil, and South Africa. It is an all-cap fund that invests in a wide range of sectors within these emerging economies.
- 8.3% in Vanguard Real Estate Index Fund ETF (VNQ). The VNQ is a real property-centric ETF that invests in a diversified list of REITs. These trusts buy properties ranging from apartment buildings to data centers to cell towers, sharing their profits with their investors.
- 8.3% in SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL). To address the cash allocation prescribed by the portfolio strategy, Treasury bills (T-bills) are a great way to go. The BIL fund provides diversified exposure to T-bills with maturities ranging from one to three months.
- 8.3% in Vanguard Total Bond Market Index Fund ETF (BND). The BND fund is built of taxable, dollar-denominated bonds excluding inflation-protected and tax-exempt bonds. The bonds included have a range of maturities, helping to balance risk.
- 8.3% in Vanguard Total International Bond Index Fund (BNDX). The BNDX fund is an ex-U.S. bond fund, meaning it invests in a wide variety of bonds around the world with the exception of dollar-denominated bonds.
- 8.3% in iShares TIPS Bond ETF (TIP). The TIP fund invests in a diversified list of Treasury inflation-protected securities.
- 8.3% in Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC). The PDBC fund tracks commodity futures and other financial instruments that provide economic exposure to the world’s most heavily traded commodities.
- 8.3% in SPDR S&P Global Natural Resources ETF (GNR). The GNR fund invests in the largest domestic companies in the natural resources market, including energy, agriculture, and metals and mining companies.
Pro tip: You don’t have to build the portfolio yourself. You can use expert pies in your M1 Finance brokerage account to mirror the prebuilt portfolios of some of Wall Street’s greatest minds. Check out the 7Twelve Portfolio pie at M1 Finance to get started immediately.
Adding Risk Premium Factors to the Equation
As mentioned above, the 7Twelve strategy leads to a heavily diversified portfolio with a safe-haven tilt. With such a heavy tilt toward safe assets, it’s wise to consider making adjustments to increase the portfolio’s total return.
One of the best ways to do so is by adding small-cap value stocks to the mix. After all, smaller companies are known for outperforming their larger counterparts in the long run, while value stocks are known for outperforming growth stocks over long periods.
To add small-cap value to the equation, you’ll want to get rid of the VB, VO, and VEA funds altogether. This will open up just under one-quarter of your investing funds for other assets.
From there, invest this 24.9% in the Vanguard Small-Cap Value Index Fund ETF (VBR). The fund was designed to provide diversified exposure to small companies that display strong value characteristics.
Keep Your Portfolio Balanced
As with any other portfolio strategy, balance is the key to success with the 7Twelve strategy. That’s especially the case when you consider the audience the strategy was designed for — one that simply can’t accept too much risk.
As time passes, some assets in your portfolio see price movements at different rates than others, slowly eroding the perfectly balanced allocation you had when you first set up your portfolio. Falling out of balance has one of two consequences:
- Risk Overexposure. Most importantly, rising stocks may take over your portfolio, leading to overexposure to risk and underexposure to the safe-haven assets that balance out the volatility.
- Reward Underexposure. Another potential result is that declining stock prices can cause your portfolio to become underexposed to equities and overexposed to safe-haven assets. In this case, your returns will be greatly diminished.
In order to avoid these issues, it’s best to rebalance your portfolio regularly.
The good news is that the 7Twelve strategy is a lazy portfolio strategy, meaning it was designed to be easy to set up and manage. You won’t have to invest hours into rebalancing, nor will you have to rebalance every day, week, or month.
On the other hand, quarterly rebalancing is a must. Investors with a medium-term view toward investing simply can’t afford to accept significant drawdown risk because they won’t have time to recover if major declines take place.
By rebalancing your portfolio every quarter, you’ll be able to enjoy the stability and protection offered by the heavy exposure to safe havens, resting assured that you won’t have to absorb substantial losses.
All told, the 7Twelve portfolio is a great option for the investors it was designed for. These are investors within reach of retirement but not quite there yet or those who have a medium-term time horizon based on their goals.
However, if you’re a younger investor with a longer time horizon, the 7Twelve approach isn’t likely to be best for you. Younger investors will be better served investing with strategies like the Bogleheads 4 Fund Portfolio that put less emphasis on safe havens and a stronger emphasis on the growth the stock market has to provide.
If you do decide to take the 7Twelve approach, it may be worthwhile to adjust your holdings based on your goals, with the risk premium factor addition described above being an example of how to go about doing so. When personalizing your portfolio, it’s important to do your research and get a good understanding of what you’re buying before diving in.