The lifestyle approach

In particular our tolerance to risk greatly increases as we approach retirement – over our own lifecycle, our appetite for holding risky products is greatly diminished when our primary purpose is to preserve capital and generate an income. Put it all together and you can build a very simple evolving lifecycle of portfolio's that transfer assets away from risky categories – equities – towards less risky categories as we approach retirement.

The ideas about building these portfolios aren't exactly the stuff of rocket science and in the US you can find plenty of sample portfolios. In particular, TD Waterhouse (which is a big online broker in the US, as well as here) has launched a series of exchange traded tracker funds that change in asset composition over time – the table below shows the changes. For example, if you're 35, you might be interested in investing in a master portfolio that is 100% equity invested with absolutely nothing in property or bonds. By contrast when you hit retirement, TD Waterhouse's fund managers would have transferred you to the portfolio that invests only 50% in equities and 40% in gilts and 10% in property REITs.

XTF Target Date Funds

It's a similar idea with an index designed by Dow Jones – called the DJ Target Date Real return indices. This index is based around a simple distinction between what are called High Risk returns – shares – and Low Risk assets – gilts and inflation linked gilts. Again, over time the varying mixture of assets changes as you approach your target retirement date – when your target retirement date is 2045, you’ll be stuffed to the limit with high risk equities (87.81%) although Dow Jones do suggest you hold a small portion in low risk assets (12.69%).

Two interesting debates drop out of these two attempts to build a simple, Lazy portfolio that changes over time – should younger people have any safe gilts at all and to what degree should pensioners invest in equities?

Conventional wisdom suggests that the young should take on the greatest risk and only invest in equities and not buy gilts which can act as a drag on returns but the Dow Jones index reflects a growing minority view that the young need to be very careful in taking on too much risk in case they destroy their future wealth.

Also many academics – including Professor Elroy Dimson at LBS – question why so many professional advisers push their retired clients towards supposedly risk free equity-lite portfolios built around gilts. According to Professor Dimson, "wealthier pensioners are actually much better equipped to take risks to boost their income than we think. Why not take on some extra risk to boost returns as their spending is subdued and many are actually still saving in their retirement?"

All in One Products – can they work?

The very simplest and laziest portfolio would probably be just one fund but how can just one fund possibly hope to capture the diversity that’s so important to produce sustainable long term returns?

Step forward a couple of exchange traded funds marketed by iShares and Deutsche's DBX tracker unit. The rather inelegantly titled MSCI WORLD TRN INDEX ETF from DBX invests in an index run by Morgan Stanley that tracks all the worlds' key stock markets (23 in all) – it's a market cap weighted index and invests proportionately in the largest shares of these constituent indices. This MSCI index is in reality capturing the bulk of the developed world’s equity markets but beware – its invested 54% in US companies like Exxon Mobil and GE, plus another 12% in Japan, and 11% in the UK (BP makes it on at number 6, comprising a 0.78% holding in the ETF). Crucially this is a total returns product which means that you don't get any dividends as they’re in effect built into the return of the underlying index. The total expense ratio of this product is just 0.45%. iShares also runs a similar product that tracks the same index with a slightly higher expense ratio of 0.5% although this fund does pay out dividends.

You might also want to look at a potentially very interesting alternative set of American ETFs built around something called the Capital Markets Index or CPMKTS. This is a hugely innovative idea (its designed by a company Dorchester Fund Management) in that the index is designed to capture ALL the capital markets (bond, equity based and money market deposit) on a broader basis. The index was created over nine years ago using four terabytes of compressed historical data - including government statistics and market changes. According to the designers its “designed to track the weighted average of more than 1 million securities. It covers the 2,000 largest U.S. stocks and roughly 2,131 short-term fixed-income instruments as well as 5,600 investment-grade bonds”.

A few weeks back ETF firm Claymore launched 2 funds designed to track this index family including the Claymore U.S Capital Markets Index ETF (AMEX: UEM). What's clever about this catch all index – and its accompanying ETFs – is that you can go to the company's web site – at http://cpmkts.com/ - and test out for yourself which combination of US shares, bonds and money market deposits would have worked best over the last 9 years. For example, setting the site's search to run from Dec. 31, 1979 through Jan. 31, 2008, it shows that the entire index produced average annual returns of 10% while the equities portion on its own generated 12.51%, with bonds gaining 9.13%. At the same time, money markets and other liquid investments would've made 6.72%. There's no word of a UK version of either the index or the ETFs but you can easily buy the US trackers through any mainstream UK broker.