Frank Armstrong Ideal Index Portfolio: Backtest and Analysis
Frank Armstrong is a financial advisor, author, and the founder of Investor Solutions, a registered investment advisory firm based in Miami, Florida. With over 30 years in the financial industry, Armstrong has written several books on personal finance and investing, including “The Informed Investor” and “The Intelligent Asset Allocator”. He created the Frank Armstrong Ideal Index Portfolio investment strategy.
The Frank Armstrong Ideal Index Portfolio is a globally diversified investment strategy that aims to lower the portfolio’s volatility and risk by including a mix of stocks, bonds, commodities, and real estate investment trusts (REITs). It is designed to be a passive investment strategy, so it does not involve actively picking individual stocks but, rather, invests in a diverse mix of low-cost index funds that track different market segments.
In this post, we take a look at the Frank Armstrong Ideal Index Portfolio. We end the article with a backtest of the portfolio.
Introduction to the Frank Armstrong Ideal Index Portfolio
The Frank Armstrong Ideal Index Portfolio is a globally diversified investment strategy that aims to lower the portfolio’s volatility and risk by including a mix of stocks, bonds, commodities, and real estate investment trusts (REITs).
The portfolio is designed to be a passive investment strategy, meaning that it does not involve actively picking individual stocks or trying to time the market. Instead, it focuses on buying and holding a diverse mix of low-cost index funds that track different market segments, such as large-cap stocks, small-cap stocks, international stocks, and bonds.
The FIIP is based on the idea that the best way to achieve long-term investment success is to maintain a well-diversified portfolio that tracks different market indices. One of the key features of the FIIP is it uses a strategic asset allocation approach, which aims to provide a balance between growth and income, and between risk and return. The portfolio is also rebalanced periodically to maintain its desired asset allocation.
Although the Frank Armstrong Ideal Index Portfolio is intended for long-term investors who are looking for a simple, low-cost, and diversified investment strategy, it also uses a tactical asset allocation approach, which aims to take advantage of short-term market conditions by adjusting the portfolio’s allocation based on current market trends. So, the strategy is suitable for investors of all experience levels and can be implemented with a relatively small initial investment.
Benefits of the Frank Armstrong Ideal Index Portfolio
The Frank Armstrong Ideal Index Portfolio (FIIP) offers several benefits to investors, such as:
- Diversification: The strategy is designed to provide a well-diversified portfolio that tracks a group of sector indices and market indices from different asset classes. This diversification across different market segments and asset classes helps to minimize risk and provide a balance between growth and income.
- Low cost: The strategy uses low-cost index funds and ETFs, which have lower expenses than actively managed funds. This can result in a significant reduction in investment costs over time, which can have a positive impact on long-term returns.
- Passive management: The portfolio follows a passive investment strategy — it does not actively pick individual stocks but instead, invests in index funds. This eliminates the need for constant monitoring and the potential for costly mistakes.
- Unique asset allocation model: It uses a strategic and tactical asset allocation approach, which aims to provide a balance between growth and income, and between risk and return, to minimize portfolio volatility and provide a more stable investment experience.
- Suitable for long-term investors: The portfolio’s model is suitable for long-term investors who are looking for a simple, low-cost, and diversified investment strategy. It suits investors of all experience levels and can be implemented with a relatively small initial investment.
- Global diversification: It invests in different markets around the world.
Importance of Backtesting with the Frank Armstrong Ideal Index Portfolio
Backtesting is an important part of the Frank Armstrong Ideal Index Portfolio investment strategy, as it helps to evaluate the historical performance of the portfolio and assess its potential risk and return characteristics. Backtesting allows you to see how the portfolio would have performed under various market conditions in the past, which can provide valuable insights into the portfolio’s potential performance in the future.
By simulating the portfolio’s performance over a historical period, you can get a sense of how the portfolio would have performed in different market environments. This can help you to identify potential weaknesses in the portfolio and make adjustments as necessary. For example, backtesting can reveal that a portfolio’s returns were highly correlated with the stock market during a recession. This could indicate that the portfolio may not be as well-diversified as it should be, so adjustments may need to be made to the portfolio’s asset allocation.
Also, backtesting allows you to evaluate the effectiveness of the portfolio’s rebalancing strategy. This is important as rebalancing is a key aspect of the Frank Armstrong Ideal Index Portfolio and helps to ensure that the portfolio stays aligned with your goals and objectives. By backtesting the portfolio’s rebalancing strategy, you can see how often the portfolio would have been rebalanced in the past and whether or not the rebalancing strategy helped to improve the portfolio’s performance.
Furthermore, backtesting can help to identify the portfolio’s risk-return characteristics, such as volatility, sharp ratio, and maximum drawdown. This information can help you understand the portfolio’s risk profile and make informed decisions about your investment.
Constructing the Frank Armstrong Ideal Index Portfolio
The Frank Armstrong Ideal Index Portfolio is a globally diversified index fund portfolio that is constructed using low-cost index funds. Here is a step-by-step guide to constructing the portfolio:
- Determine your investment goals: Before constructing the Frank Armstrong Ideal Index Portfolio, you have to determine your investment goals. This will help you to know the appropriate asset allocation for your portfolio.
- Select index funds: Select low-cost index funds that will be used to construct the portfolio. The portfolio typically includes index funds that track US and international stocks, bonds, commodities, and real estate investment trusts (REITs).
- Determine the asset allocation: Once you have selected the index funds, determine the appropriate asset allocation for the portfolio. The Frank Armstrong Ideal Index Portfolio uses a strategic and tactical asset allocation approach, which aims to provide a balance between growth and income, and between risk and return.
- Implement the portfolio: Once you have determined the asset allocation, implement the portfolio by allocating the appropriate amounts of each index fund to your portfolio.
- Rebalance the portfolio: Rebalance the portfolio periodically to maintain the desired asset allocation. This helps to ensure that the portfolio stays aligned with the investor’s goals and objectives.
- Monitor the portfolio: Monitor the portfolio’s performance and make adjustments as necessary. For every adjustment, you need to backtest it.
Asset Allocation with the Frank Armstrong Ideal Index Portfolio
The portfolio is constructed using low-cost index funds that track US and international stocks, bonds, commodities, and real estate investment trusts (REITs). The portfolio is typically divided into these categories:
- US stocks: The portfolio typically allocates 31% of capital to US stocks. The 31% allocation is divided into different sectors as follows:
- 6.25% Large Cap Blend
- 9.25% Large Cap Value
- 6.25% Small Cap Growth
- 9.25% Small Cap Value
- International stocks: This asset class is designed to provide diversification and reduce the portfolio’s overall risk. The portfolio typically allocates 31% of its capital to international stocks.
- Bonds: This asset class is designed to provide income and stability. The portfolio typically allocates 30% of the portfolio to bonds.
- Real Estate Investment Trusts (REITs): This asset class is designed to provide income and diversification. The portfolio typically allocates 8% of the portfolio to REITs.
In summary, the asset allocation is like this:
- 6.25% Large Cap Blend
- 9.25% Large Cap Value
- 6.25% Small Cap Growth
- 9.25% Small Cap Value
- 31% International Stocks
- 30% Short-Term Bonds
- 8% REITs
Risk Management in the Frank Armstrong Ideal Index Portfolio
Risk management is an important aspect of the Frank Armstrong Ideal Index Portfolio investment strategy. The goal of risk management is to minimize the likelihood of large losses and maximize the potential for investment returns.
The portfolio uses a combination of diversification and asset allocation to manage risk. With diversification, the portfolio spreads its investments across different asset classes, sectors, and geographic regions. The portfolio is constructed using low-cost index funds that track US and international stocks, bonds, and real estate investment trusts (REITs). This spreads out the risks and helps to reduce the portfolio’s overall risk.
The portfolio uses a strategic and tactical asset allocation approach to provide a balance between growth and income, as well as between risk and return. It also regularly reviews and rebalances the portfolio to maintain the desired asset allocation. This helps to ensure that the portfolio stays aligned with the investor’s goals and objectives.
With the tactical allocation method, the portfolio considers the market conditions when allocating and rebalancing assets. While the strategic allocation shares assets based on the long-term strategic goals of the portfolio, the tactical aspect considers the market conditions in the short term.
Rebalancing the Frank Armstrong Ideal Index Portfolio
Rebalancing is an important aspect of the Frank Armstrong Ideal Index Portfolio (FIIP) investment strategy. It involves adjusting the portfolio’s asset allocation to align it with the investor’s goals and objectives, and to ensure that the portfolio stays diversified and risk-controlled.
The portfolio uses both strategic and tactical asset allocation methods. The aim is to provide a balance between growth and income, and between risk and return. the tactical method puts the market conditions into consideration when making asset allocation and rebalancing.
Rebalancing is typically done on a regular basis, such as quarterly or annually. The process involves selling the assets that have increased in value and using the proceeds to buy assets that have decreased in value. This helps to maintain the desired asset allocation and reduce the risk of the portfolio.
Rebalancing also helps to lock in profits and reduce risk. When an asset class has performed well and its share of the portfolio has grown, rebalancing may involve selling some of those assets to bring the portfolio back to its target allocation. This can help to lock in profits and reduce the risk of the portfolio by selling assets that have become overvalued.
One more thing: there are many different ways to rebalance the portfolio, including time-based, threshold-based, or a combination of both. Time-based rebalancing is where the portfolio is rebalanced at a regular interval, such as annually or semi-annually. Threshold-based rebalancing is where the portfolio is rebalanced when an asset class deviates from its target allocation by a certain percentage.
Applying the Frank Armstrong Ideal Index Portfolio
The Frank Armstrong Ideal Index Portfolio is implemented by investing in low-cost index funds. It can be achieved with these seven exchange-traded funds (ETFs):
- Vanguard FTSE All-World ex-US ETF (VEU): Invest 31% of the portfolio in VEU, which is an ETF that focuses on global equity markets, excluding the United States, and primarily invests in large-cap stocks.
- iShares S&P Small-Cap 600 Value ETF (IJS): Invest 9.25% of the portfolio in IJS, which focuses on small-cap stocks in the United States that are considered undervalued.
- Vanguard Value ETF (VTV): Invest 9.25% of the portfolio in VTV, which focuses on large-cap stocks in the United States that are considered undervalued.
- Vanguard Real Estate ETF (VNQ): Invest 8% of the portfolio in VNQ, which focuses on real estate investment trusts (REITs) in the United States.
- iShares S&P Small-Cap 600 Growth ETF (IJT): Invest 6.25% of the portfolio in IJT, which focuses on small-cap stocks in the United States that are considered overvalued.
- Vanguard Large-Cap ETF (VV): Invest 6.25% of the portfolio in VV, which focuses on large-cap stocks in the United States.
- iShares 1-3 Year Treasury Bond ETF (SHY): Invest 30% of the portfolio in SHY, which focuses on short-term bonds issued by the United States government.
Backtesting the Frank Armstrong Ideal Index Portfolio
Backtesting the Frank Armstrong Ideal Index Portfolio involves evaluating the historical performance of the portfolio using past market data. Here are the steps to backtest the portfolio:
- Gather historical data for the ETFs that make up the Frank Armstrong Ideal Index Portfolio. This data should include the ETF’s closing price, dividends, and other relevant financial information for the time period you wish to backtest.
- Create a spreadsheet or use software to input the historical data for each ETF and calculate the portfolio’s performance using the specified weights for each ETF.
- Use the historical data to calculate key metrics for the portfolio, such as return, risk, and volatility.
- Compare the portfolio’s performance to relevant market benchmarks, such as the S&P 500 index, to evaluate the portfolio’s performance in relation to the broader market.
- Analyze the portfolio’s performance over different market conditions, such as bull and bear markets, to evaluate the portfolio’s ability to weather different market environments.
- Repeat the backtesting process multiple times with different historical data to evaluate the portfolio’s performance over a longer period.
- Evaluate the results of the backtesting process to determine if the portfolio’s performance meets your investment objectives.
Evaluating the Performance of the Frank Armstrong Ideal Index Portfolio
Evaluating the performance of the Frank Armstrong Ideal Index Portfolio involves analyzing various metrics to understand how the portfolio has performed over a given period of time. Here are some steps to evaluate the performance of the portfolio:
- Calculate the portfolio’s return and risk profile over a specific time period, such as a year
- Analyze the portfolio’s risk-adjusted return, such as the Sharpe ratio and Sortino ratio, to evaluate the portfolio’s risk-adjusted performance.
- Compare the portfolio’s volatility to relevant market benchmarks, such as the S&P 500, to understand how the portfolio has performed in relation to the broader market
- Crosscheck with your investment objectives to determine if the portfolio’s volatility is in line with expectations.
- Evaluate the portfolio’s diversification by analyzing the correlation between the ETFs in the portfolio and their contributions to the portfolio’s overall risk.
- Analyze the portfolio’s performance over different market conditions, such as bull and bear markets, to understand how the portfolio has performed under different market environments.
In conclusion, the Frank Armstrong Ideal Index Portfolio is a globally diversified investment strategy that can be implemented by investing in a combination of ETFs that track various asset classes, including global equity, U.S. small-cap value and growth stocks, U.S. large-cap value and growth stocks, U.S. real estate, and short-term U.S. bonds. The portfolio’s allocation is divided among the various ETFs in a specific weight to achieve the desired level of diversification and risk management.
FAQ:
How does the FIIP differ from other investment strategies?
The FIIP is a globally diversified investment strategy designed by financial advisor Frank Armstrong. It aims to minimize portfolio volatility and risk by including a mix of stocks, bonds, commodities, and real estate investment trusts (REITs). The FIIP is a passive investment strategy that avoids actively picking individual stocks. Instead, it invests in low-cost index funds, providing a well-diversified portfolio.
What are the key features of the FIIP?
The FIIP utilizes both strategic and tactical asset allocation approaches to balance growth and income, as well as risk and return. It is periodically rebalanced to maintain the desired asset allocation. This model’s Benefits include diversification across different market segments and asset classes, low costs due to the use of index funds, passive management, a unique asset allocation model, and suitability for investors of all experience levels.
How is the FIIP constructed, and what are its asset allocations?
The portfolio includes index funds tracking US and international stocks, bonds, commodities, and REITs. Asset allocations typically cover US and international stocks, bonds, and REITs. Backtesting evaluates the historical performance of the portfolio under various market conditions, helping investors understand its potential risk and return characteristics.