I’ve edited this post to clarify a few things, and to add information researched by GRS readers. Thanks!

The average investor cannot beat the market on a regular basis. For her, index funds are the best investment. Even a majority of professional money managers fail to beat the market most of the time. However, there are those — like Warren Buffett — who seem to have a sort of financial genius, who are able to consistently earn stellar returns. David Swensen is one of these people.

For the past 21 years, Swensen has helped to manage Yale University’s investment portfolio to an average 16 percent annual return. But Swensen has billions of dollars to work with. This allows him to do things that you and I cannot.

In a recent interview with NPR, Swensen shared a model investment portfolio for individual investors that he believes can generate good returns while mitigating risk. I’ve excerpted NPR’s version of the portfolio below. For each class, I’ve included [in brackets] the Vanguard fund that Swensen believes is most appropriate, as well as my own attempt at finding an equivalent exchange-traded fund (ETF). Your own research might produce other alternatives:

The chart below represents Swensen’s basic formula for creating an investment portfolio likely to give you good returns while still managing risk:

  • Domestic Equity (30 percent): Refers to stocks in U.S.-based companies listed on U.S. exchanges. [Vanguard: VTSMX, ETF: VTI]
  • Emerging Market Equity (5 percent): Refers to stocks from emerging markets around the world, such as Brazil, Russia, India and China. [Vanguard: VEIEX, ETF: VWO]
  • Foreign Developed Equity (15 percent): Refers to stocks listed on major foreign markets in developed countries, such as the United Kingdom, Germany, France and Japan. [Vanguard: VGTSX, ETF: VEU]
  • Real Estate Investment Trusts (20 percent): Refers to stocks of companies that invest directly in real estate through ownership of property. [Vanguard: VGSIX, ETF: VNQ]
  • U.S. Treasury Notes and Bonds (15 percent): These are fixed-interest U.S. government debt securities that mature in more than one year. Notes and bonds pay interest semi-annually. The income is only taxed at the federal level. [Vanguard: VFISX, VFITX, and VUSTX; ETF: BND]
  • U.S. Treasury Inflation-Protection Securities, or TIPS (15 percent): These are special types of Treasury notes that offer protection from inflation, as measured by the Consumer Price Index. They pay interest every six months and the principal when the security matures. [Vanguard: VIPSX, ETF: TIP]

I’ve been looking for guidance on how to construct a portfolio of index funds. My debt will be paid off soon, and my focus will shift to investing. Swensen’s model sounds like a good basis from which to begin. Note that his recommendation is for some mythical average person. It’s a starting point. It’s important to make informed investment decisons that work for your goals.

Here are historic returns and analysis of the portfolio, as uncovered by sagar. Check the comments for more great tips on how a model portfolio can be molded to fit our needs (and discussion on whether it should be used at all!).

[NPR: Yale outsmarts the market, via Vintek]

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