That's the most common question readers have about the Couch Potato Portfolio, my tool for the incurious and slothful who want to manage their money with as little time, effort, and expense as possible but still get life-sustaining results.
The sexy next level comes from William J. Bernstein, an Oregon neurologist who has pursued his hobby of statistics and portfolio theory with such passion that he first created an online publication--- Journal of the Efficient Frontier, then started writing for outfits like Morningstar, and now has published a book, "The Intelligent Asset Allocator --- all in his proverbial "spare time, at home."
While not intended as beach reading, Bernstein makes such direct and lucid connections between statistical analysis, probability, and the workings of investment management that anyone who would like to know about the connection without actually doing the work (or taking Statistics 101) should read his book.
Dozens of investment books cross my desk every year; few are retained, let alone mentioned in my column. But Bernstein's book is 'a keeper'--- something that should be in the basic library of every serious investor.
So what's the basic idea?
Build your portfolio with multiple classes of assets, invest entirely in index funds because professional stock and bond picking is a waste of time and money, and rebalance your portfolio regularly so that it maintains its original proportion for each asset class.
While Bernstein himself is an admitted "asset-class junkie", wanting as many asset types in his portfolio as possible, his easiest model portfolio is a mixture of four types of assets:
• U.S. large stocks, such as the stocks in the S&P 500 Index
• U.S. small stocks, such as the stocks in the Russell 2000 Index
• Foreign Stocks, such as the stocks in the EAFE Index
• And U.S. short-term bonds.
All four of these asset classes are available as inexpensive, no-load mutual funds and, Bernstein says, "if history is any guide a portfolio divided equally among these four assets will most likely outperform the overwhelming majority of investment professionals over the next few decades."
Skeptical readers are likely to wonder how anything with foreign stocks could compete, since foreign stocks have wrecked diversified portfolios for more than five years. They might also wonder about small stocks, knowing that the Russell 2000 index has trailed the S&P 500 Index by 5.5 percent a year, compounded, for the last 15 years.
In fact, Bernstein shows that while an equal mix of the three equity classes--- the S&P 500, Small stocks, and foreign stocks--- would have provided wildly different returns from a pure S&P 500 investment in each of the five year periods from 1969 to 1998, the mixed portfolio was within a hair of the S&P 500 over the entire period, 12.50 percent and 12.67 percent, respectively.
In turn, the S&P 500 index beat the vast majority of professionally managed equity funds over the period.
Is it that simple? Don't you need an advisor to help you set the allocation for each asset?
Using the investment tool with the greatest mystique, a mean variance optimizer, Bernstein shows that if you had used an optimizer (the tool touted by many professionals) to select from six asset classes starting in 1975, your return would have been only 8.4 percent a year. An equal mix of all six assets--- which he calls "The Coward's Portfolio"--- would have produced a return of 15.79 percent over the same period, very close to the 17.1 percent return of large cap stocks and ahead of most professionally managed domestic equity portfolios.
Your portfolio, in other words, needs no special knowledge of the future. But if you want it to be more complicated than splitting your money between domestic stocks and domestic bonds, Bernstein shows the way.
Visit his website
Tuesday: How is it that indexing works so well?
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
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