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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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October 3rd, 2007 at 2:30 pm
With the exception of Real Estate (interesting addition), this looks a lot like the Couch Potato portfolio that Ben Stein and Phil DeMuth talk about in one of their books.
What is an Exchange Traded Fund? I’m guessing that this means it is traded on, say, NYSE, and that Vanguard isn’t?
October 3rd, 2007 at 2:51 pm
The one problem with this portfolio is that it doesn’t take into account the age/years-to-retirement of the investor. I think this has a lot more fixed income than would be recommended to someone in, say, their 20s, too much equities for someone in their 60s, etc.
SusanO: yes, an ETF is more or less an index fund that’s traded on an exchange, as opposed to a mutual fund. People buy them if they want to actively trade against an index, or if they don’t meet minimum investment requirements for a similar mutual fund. Buying and selling ETFs will incur brokerage fees.
October 3rd, 2007 at 4:06 pm
I’m more interested in hearing about how we can protect our 401K life savings from the inevitable market crash?
October 3rd, 2007 at 4:29 pm
I definitively like the portfolio advice over at Sound Investing (I regularly listen to their podcast):
http://www.fundadvice.com/home/
October 3rd, 2007 at 4:48 pm
JD: VGTSX is a total int’l index. It is a fund of funds and holds about 20% emerging markets. VDMIX is probably what Swensen had in mind. That said, VGTSX or the FTSE Ex-US (which holds Canada and is more tax-friendly but has a higher ER) fund at Vanguard are simpler options than holding developed and developing market int’l funds.
That he stays away from ANY risk in his fixed income portion is probably a reflection of Swensen’s strong desire to have uncorrelated asset classes. I often read that this is the way to go.
By the way, ETF’s also have really low fees (compared with their investment firm equivalent), so they can be a good idea if you don’t plan to make regular contributions and have a lump sum to invest. I’m not in that boat.
October 3rd, 2007 at 4:54 pm
Agree 100% that indexing is the way to go unless you get into real estate or investing in startup ventures (angel funds and VC).
I don’t agree that one portfolio allocation strategy can work for everybody. This needs to be tailored to an individuals investing objectives but Mr. Swenson’s model could be a good starting point.
October 3rd, 2007 at 5:36 pm
A Vanguard alternative to EFA would be VEU.
A Vanguard alternative to AGG would be BND.
Both of these are new ETFs this year.
October 3rd, 2007 at 5:43 pm
Jessica:
About the only way to “protect our 401K life savings from the inevitable market crash” is to hold it entirely in cash.
Otherwise, your best strategy is to follow the sort of diversification talked about in this portfolio, where your money is spread between different categories of investing (including something in fixed income areas, and taking into account your time horizon). That is because:
1. It would be a really shocking apocalyptic sort of event for ALL these sectors to totally fail at the same time, in which case it really wouldn’t matter since not even money stuffed under your mattress would help you.
2. Barring 1 and barring unprecedented governmental seizure of the markets, what goes down in the markets will eventually rise again.
By taking your time horizon into account, you are also protecting yourself. If you are in your 20s you have time to recover from a disastrous downturn that could happen in the next few years. If you are in your 50s or 60s, you don’t have that same time and so need to be invested MUCH more conservatively.
On the other hand, if you are in your 20s and 30s and stuff it all in your sock drawer out of fear of a crash, you might as well start stockpiling the Alpo now.
October 3rd, 2007 at 6:06 pm
While I’m not authorized to give guidance of any kind, I recommend you check out the lazy portfolio that I set up. I think there might be some good alternatives to the foreign, real estate, and bond ETFs that you suggest.
October 3rd, 2007 at 6:08 pm
Personally, I think it’s too low on foreign stocks and is susceptible to dollar devaluation.
October 3rd, 2007 at 6:12 pm
Don’t forget that this model is designed for an average return of only 6% - it just happened to do better than the market…A lot less risky though.
October 3rd, 2007 at 6:37 pm
I just found this on Swensen’s wiki:
http://www.icarra.com/viewPortfolio.php?id=258
Perhaps you all might be interested to see historic results and analysis of the portfolio.
October 3rd, 2007 at 6:42 pm
J.D. — ETF’s are not a good choice if you are going to be making regular investments, as you pay a sales commission each time you purchase.
Let me just tell you that Vanguard has the cheapest index funds, so just go w/ them for all your indexing. Okay, you want a fund that’s gonna track the entire American stock market, so get Vanguard’s Total Stock Market Index. You also want an international fund that’s going to track both EFA and EEM, so simply get Vanguard’s Total International Stock Fund. This would be a good stopping point, but if you want an index fund for real estate, then get Vanguard’s REIT Index Fund. If you want a bond index fund, get Vanguard’s Total Market Bond Index Fund.
October 3rd, 2007 at 6:54 pm
That has 30% (t-bonds, tips) in funds that will return around 5% per year. If you are younger than your late 40s or early 50s, you should not have that much invested in those. If you are older than that, you should probably have more.
To whit, in a good year for equities, you’d only get an 8.5% return. In a bad year for equities, you’ll get a 1% return, as opposed to a loss. that sort of seems like not much downside protection to me, and too much upside lost.
And though investing in real estate is a fine idea, if you purchase property to live in, you are de facto invested in real estate, so an extra 20% in your investment portfolio seems like you might be overweight real estate.
October 3rd, 2007 at 6:56 pm
October 3rd, 2007 at 7:10 pm
Paul B. Farrell at MarketWatch has had a regular (quarterly, I believe) feature for years now, tracking the performance of “Lazy Portfolios”, including the Swenson’s portfolio and the Margarita Portfolio (successor to the Couch Potato Portfolio). The portfolios range from 3 to 11 funds. All are predicated on the concept that a well balanced asset allocation of low cost index funds will beat the market while mitigating risk. See the link below for the latest edition:
http://www.marketwatch.com/news/story/eight-lazy-portfolios-sure-to-volatile-fourth/story.aspx?guid=%7B6F51DDEF%2D5E28%2D4A82%2D8E09%2DDD7066D476A4%7D
The portfolios can, of course, be tweaked to align with a person’s individual risk tolerance. My own opinion is that a novice, or even experienced, investor could do very well by following the post of September 18th of this very blog (see link below):
http://www.getrichslowly.org/blog/2007/09/18/lifestyles-of-the-rich-and-boring/
October 3rd, 2007 at 7:50 pm
My parents set up “competing” lazy portfolios: Mom’s is adapted from William Bernstein’s, “Four Pillars of Investing” and Dad’s is from the CoffeeHouse investor. Both have performed about the same, but Bernstein’s portfolio has a slight lead after 3 years. Bernstein’s “Four Pillars” is a great book, but has a heavy, academic feel. The CoffeeHouse portfolio is much more basic.
October 3rd, 2007 at 7:51 pm
Parallels: Investment Portfolios | Marketing Portfolios…
As many a marketing manager and media planner turns their focus to 2008 (in fact, I’m better that a fair number of you have already turned in some preliminary budget numbers for ‘08, if not your entire budget and marketing plan) we’re all challenged…
October 3rd, 2007 at 7:55 pm
Given all of the Vanguard talk I’d like to recommend The Bogleheads’ Guide to Investing. It was a pretty good book and they really like the low cost index funds. They’ve got an online forum at http://diehards.org with a lot of good info. Some of the users on that site recommended that I go with the Target Retirement Fund over the 80/20 Stock/Bond Index mix though and move into individual funds after I get older and build up a bigger portfolio. I guess the Targeted fund provides better diversification.
October 3rd, 2007 at 8:34 pm
For a highly informative, and detailed read on index investing and risk vs. return profiles, check out Frank Armstrong’s: The Informed Investor.
If you’ve read the Coffeehouse book, you’ll recognize many of the concepts, but Armstrong goes much deeper into modern portfolio theory and how you can maximize returns while minimizing risks. His portfolio allocations look a lot like Swensen’s–which is no surprise. As Armstrong points out, this is how many pension funds allocate their monies for maximum gain with lowest amount of risk.
I have been following a slightly modified Informed Investor / Coffehouse investing strategy for the last few years and have been pleased with the results. You won’t get the astronomical gains you get from playing the ponies; however with this allocation model my funds have chugged steadily upwards when the market heads north, and they don’t seem to give up too much ground when all hell is breaking loose. I sleep soundly at nights now–unlike during the .com meltdown where I lost a significant percentage of my net worth in individual stocks.
If you’re interested in checking out Armstrong’s investment company, just Google his name + “Investor Solutions”. Please note that I do not have any investments nor affiliations with Armstrong or his company.
October 3rd, 2007 at 9:41 pm
The numbers for this portfolio for the past 35 years:
Swenson:
11.8% nominal return (6.6% real)
11.2 standard deviation
100% Total Domestic:
11.25% nominal return (6.25% real)
17.5 standard deviation
So despite having 30% bonds, it returned just as much 100% total domestic stock with 60% of the volatility. Even though there’s a general rule that portfolios holding more stocks will have higher returns, the exact breakout matters. Having different asset classes that zig when others zag — and rebalancing to take advantage of it — can make a marked difference in performance.
October 4th, 2007 at 4:17 am
And VinTek has beat me to it. I was going to mention Farrel as well. He has a number of good looking portfolios included, with different amount of risk and diversification. But even the simplest is good in the long run.
October 4th, 2007 at 6:43 am
The more money you manage the harder it is to make such great returns so Mr. Swensen should receive extra applause for his work.
However, I don’t see this asset mix as something the individual investor should follow.
For the individual, with small amounts of money and not retiring in say the next ten years, bonds would be a waste. Real estate funds or REITS are generally not a good idea on their own either (too many fees and not really extra diversification from the stock market)- just go out and buy some investment property on your own if you desire to own real estate.
October 4th, 2007 at 7:38 am
This might be a good outline for somebody who is starting out with zero knowledge of the stock market, but don’t forget that little caveat at the bottom of every investment website, publication, or prospectus:
“Past performance does not guarantee future returns.”
Don’t fall into the trap of listening to “experts”. Remember, if he was THAT good, he wouldn’t be sharing his million dollar ideas with anyone within earshot. In fact, his million dollar idea is to dupe you into thinking he has a wonderful secret to share!
October 4th, 2007 at 7:46 am
@David-
Actually, I think don’t think you’re taking into account that we’re in a global economy and that a large number of US companies have a global presence. For example, dollar devaluation helps exporters like Boeing, which has been selling airplanes like crazy on the global market while at the same time helping with hefty margins. Contrast that with Airbus, which is currently stuck selling airplanes at dollar prices to remain competitive, but incurring costs in Euros. That said, my own asset allocation does include much more international exposure, especially in EM, but then again, I’m not particularly risk-adverse.
Note too, that if the Chinese ever allow their currency to float, it’s economy will probably take an enormous hit, even though its currency would likely skyrocket against the dollar.
@FinanceAndFat,
The key to REITs is diversification of real estate assets. While the typical investor probably is amply in real estate by the simple virtue of owning a house, someone with more resources could find REITs a viable investment vehicle, since such trusts not only include housing, but also commercial property (like hotels and storage), golf courses, timberland, etc. and also be diversified internationally, which properties all over the globe. Investment properties are as much a business as an investment; I tend to categorize them somewhat differently from passive investments.
October 4th, 2007 at 11:11 am
One thing that folks like Warren Buffett, Charlie Munger, David Swensen, Lou Simpson, and many other successful investors have in common is that they do not diversify. They find the best companies out there, buy shares, and then wait.
Why invest in, say, an S&P 500 index fund? It has, by definition, 500 companies in it. Is there anything else in life where you would put money into your 500th best idea?
I suggest spending time researching and investing in your top 5-10 ideas. That is the only way to generate Warren Buffett type returns. Those folks ar reading the same public material we have access to.
Don’t have time? If you have time to read this post and thread of comments, you have time to read in income statement.
This is just my 2 cents. It is your money, why pay someone else to do what you can do better.
October 4th, 2007 at 11:32 am
If you have the time to intelligently research stocks to make informed purchases, then you ought to only own a small number. But if you don’t have the time or the education to do this, then you ought to stick to index funds.
October 4th, 2007 at 12:51 pm
I am reasonably comfortable with risk and have a long time horizon (am 37); here’s my asset allocation:
65.00% - CREF Equity Index (TCEIX)
15.00% - TIAA-CREF Int. Equity Fund (TRIEX)
20.00% - CREF Bond Market (N/A)
I have my money with TIAA-CREF presently as I used to work in higher ed., but am considering opening an account at Vanguard and investing there (similar asset allocations).
I have to say that anyone investing for the long-term (and isn’t that most saving for retirement . . . ?) would do well to avoid ETFs (even if they indexed in some way) — paying any trading fees is not going to serve long-term objectives.
Oh, and one more thing, unless you have lots of money, and time to invest in intelligent research, investing in individual stocks is suspect (to say the least . . . ).
Low-cost index funds are the best thing to happen to the individual investor. (Read anything by John Bogle and learn about the “scams” that are most mutual funds . . . )
( http://www.vanguard.com/bogle_site/sp20061026.htm )
October 4th, 2007 at 12:53 pm
In addition to J.D.’s point about the amount of work Buffett, etc., put into their investing, it should be noted that part of what Buffett does isn’t “investing” in the sense of what we’d do. He can and has taken large positions in the companies he buys, and thereby influences how the company is managed, its direction, etc. Part of the return he gets is due to things like that, not just passive investments.
October 4th, 2007 at 1:45 pm
@Randy,
“I suggest spending time researching and investing in your top 5-10 ideas. That is the only way to generate Warren Buffett type returns.”
Not so. You can do so by having Warren do the work for you. Why not just buy BRK-B and be done with it? I’m recommending BRK-B because most of us can’t afford BRK-A.
Now I’ll play Devil’s Advocate. If you believe in active management in your own portofolio, why not just buy an actively managed fund? Contrary to your belief, those folks are not just reading income statements. They’re visiting companies, quizzing CEOs and CFOs, etc. Are you able to do the same?
October 4th, 2007 at 1:57 pm
First, for all those who say you have to pay commission fees with ETFs, check out zecco.com. $0 commissions. Also, Vanguard has an excellent calculator to determine whether their ETF or Index fund equivalent is cheaper over time — even when I put in paying $10 per buy (which I don’t do with zecco) and buying $500 or $1,000 dollars every month, the calculator has me saving in every instance with the ETF.
Second, the one issue that never seems to be addressed in books or online is what to do with the 401K selection you are stuck with at your company. For example, my 401K has no foreign index fund and I don’t have enough money out of my 401K to make up the difference to achieve the 40% foreign I’m looking for. So is it better to stay diversified and choose a foreign fund in my 401K with a high fee (1.3%) or is it better to be undiversified and pay low fees (e.g., the domestic index my 401K makes available)? My instinct tells me the former, and that’s what I do, but it makes me ill to know I’m paying a point or more in fees than I would if an index or ETF was available to me.
Does anyone have thoughts or experience with this issue?
October 4th, 2007 at 3:33 pm
Just looked it up - $3970 per share! Thanks for the giggle.
I agree about wanting more advice for those of us stuck with limited choices thru our employer’s 401k/403b/whatever plan manager. Guest blog anyone?
Regarding Swensen’s Real Estate wedge of the pie - I thought he was talking about actual real estate investment propery, not REITs. I disagree about one’s house being investment property, since it doesn’t bring in ongoing income as true investments do, whether it’s stocks, bonds, or apartment houses.
October 4th, 2007 at 4:50 pm
Re BRK-B — it’s always possible through some brokers to buy fractional shares. For example, Sharebuilder will let you buy fractional shares.
You could buy a share of BRK-B in $100 hunks if you really wanted to (and if you schedule the trade rather than make it in real-time, with only a $4 transaction fee.)
I’m not necessarily advocating this, just pointing out you don’t need to cough up $4K just to participate in Buffet’s genius.
Otherwise — dealing with what your 401(k) plan allows is my own huge dilemma. And my employer lets us do a self-managed account at Charles Schwab even. The problem is the Schwab account charges a hefty $50 transaction fee to buy or sell either the Vanguard or T Rowe Price retirement funds, which would be my first choice. I can buy Vanguard ETFs for a $12.95 transaction fee.
They do have a selection of no-load mutual funds but it’s always been hard finding a mix I really like. And their no-load index funds options suck finance charge wise — for those charges I may as well find an inexpensive managed fund.
October 4th, 2007 at 8:05 pm
You can also consider investing into a fund that invests heavily into Berkshire Hathaway. I have a small chunk of money in the Fairholme Fund (FAIRX) of which Bershire Hathaway comprised 17.76% of its holdings as of the 31st of May. Although it has a relatively high expense ratio of 1%, I feel the money is well spent. Since its inception in late 1999, $10,000 invested in The Fairholme Fund with dividends reinvested
has grown to $35,206 while $10,000 invested in the S&P 500 Index with dividends
reinvested has grown to $11,613 (through 31 May).
Also, consistent with Randy’s approach, it’s a rather concentrated fund with 69.5% of its value in its top 10 holdings.
October 4th, 2007 at 9:54 pm
MossySF Says:
So, holding 6 funds with 6 times the cost of 1 and some degree more time & effort monitoring & rebalancing gets you .55% higher return per year and lets you sleep 6% easier per year?
So 1,000 per year is $402,824 vs $460,444 in 35 years.
at 10, its 18828 vs 19430.
at 20, its 73507 vs 78000.
I guess that’s worth it….you’d have to invest $150 more per year to match it, or it would take 36 years to match the gain of 35 year diversified fund.
Or you could just choose a US small cap firm and a large cap at 50/50, and easily surpass it. Or you could just ditch the bonds, have the 4 equity funds mentioned above and blow it out of the water.
Whichever is easiest.
October 5th, 2007 at 3:00 am
Can We Turn Off Our Emotions When Investing?
(or why we can’t…)
from New York Times
http://tinyurl.com/2n978g
October 5th, 2007 at 4:45 am
Interesting timing, since I just posted my retirement plan asset allocation on my blog Tuesday.
http://bloggingawayat.blogspot.com/
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October 18th, 2007 at 6:48 pm
@cms: Find out who administrates the 401k offerings at your company and petition him or her to add more offerings and/or change investment firms. This is what most of the books advocate…
October 29th, 2007 at 11:37 am
Randy is absolutely right. Diversification is a method to deal with a lack of knowledge. So knoweing the right investments to make would of course be better. The problem is in knowing the right investments to make. And others are absolutely right that we don’t have the man-hours of Buffet. And we don’t have the advantages of leverage that he and all the other big-time investors do. I can’t exactly swoop in and by a 20% share of a company and demand a board seat.
But I can invest in those that do. I still think BRK is a good investment. I know some people are put off by the cost per share, but who cares if you own only a small number of shares? Yes, there’s a clear cost of entry, but it has advantages, in that it is much harder to day trade BRK than a stock that’s split a thousand times. Remember, stock splits do not create value. They create a lower barrier to entry.
I don’t mean to belittle the fact that $4K is a lot of upfront cost and not something everyone can handle. But it isn’t terribly more than what many mutual funds require as an initial investment.