Crafting the ideal investment portfolio is an intensely debated topic among investors. With the wide selection of options, from equities to fixed income to real estate and more, allocating your hard-earned money into a portfolio allocation can be daunting. Experts promote varying philosophies, ranging from simplicity to complexity.
While no asset allocation is the best for every investor, some portfolio frameworks have become the most popular. These strategies provide guidelines for investors aiming to diversify their holdings across various asset classes in a straightforward, inexpensive way. Whether you’re a novice or a seasoned investor, grasping the logic behind different portfolio construction concepts can equip you with the knowledge to refine your investment plans. This article will explore the nine most frequently discussed portfolio tactics among seasoned investors and explain how to execute these models using low-cost index funds or ETFs.
1. Single Fund Strategy
The most basic portfolio allocates 100% to a single broad stock market index mutual fund or ETF. The most common tactic is utilizing an S&P 500 fund like VFINX or a total US stock market fund like VTSAX. This tactic puts you fully invested in 500+ major US firms or over 4000 US companies. The SPY ETF can also be used for this strategy. While it may appear overly simple, this tactic has produced stellar long-term returns for most investors on long-term time frames of 10 to 20 years. However, the instability of being wholly in equities makes it a risky tactic nearing retirement. This can be an excellent tactic for young people with decades to dollar cost average into this strategy. It is also ideal to start during a bear market.
To implement this tactic, decide if you want exposure solely to the S&P 500 or the US stock market. This strategy invests 100% of capital in the portfolio into VFINX, VTSAX, or SPY. Keep investing all contributions into the single fund. It reinvests all dividends back into buying more shares in the index funds. This is the strategy Warren Buffett used to beat hedge funds in a challenge.
2. Two Fund Strategy
The next step up in complexity is the two-fund portfolio. Here you diversify your stock holdings with some bonds for stability and income. A straightforward approach is 90% in a total US stock market fund like VTSAX and 10% in a total US bond market fund like VBTLX. This generally follows the guideline of your bond allocation percentage matching your age. As you get older, more goes into bonds to reduce risk. This two-fund strategy is the portfolio approach Warren Buffett has set for his wife’s trust so she can receive the income from the bonds and let the stock portion of the portfolio grow.
To implement this tactic, this strategy directs 90% of investment capital into VTSAX and 10% into VBTLX. Over time, shift more to bonds as you age. Rebalance annually to maintain the target allocation. This also locks in stock market gains during bull market runs during portfolio reallocation.
3. Three Fund Strategy
This is the standard simple three-fund portfolio made famous by the Bogleheads. In addition, you add exposure to international stocks for further diversification to total US stocks and bonds. A typical split is 60% VTSAX, 30% VBTLX, and 10% VTIAX. The discussion around whether international funds are beneficial is highly debatable, but adding some provides a safety net if US markets underperform and create opportunities to profit from economic growth in other countries.
This strategy allocates investment dollars into three funds: 60% VTSAX, 30% VBTLX, and 10% VTIAX. Rebalance yearly to maintain the target allocation.
4. Three Fund Plus One Strategy
This takes the three-fund portfolio and supplements a REIT (real estate investment trust) fund for real estate exposure. An example allocation would be 55% VTSAX, 25% VBTLX, 10% VTIAX, and 10% VGSLX. REITs allow you to invest in real estate properties and firms without directly owning physical property. This fund invests in real estate investment trusts—companies that purchase office buildings, hotels, and other real estate property. REITs have often performed differently than stocks and bonds, so this fund may offer some diversification to a portfolio already made up of stocks and bonds.
This strategy directs investment dollars to allocations similar to 55% VTSAX, 25% VBTLX, 10% VTIAX, and 10% VGSLX. Rebalance annually to maintain allocation. You can also choose your assignments based on how aggressive you want to be with any one investment.
5. Dave Ramsey Four Fund Strategy
Well-known radio host Dave Ramsey advocates holding four actively managed mutual funds in equal weights: growth & income, growth, aggressive growth, and international. Given the high expenses of active funds rarely lead to beating the benchmark index, investors can mimic the tactic using low-cost Vanguard index funds at 25% of capital each in VFINX, VIMAX, VSMAX, and VTIAX. One drawback is the lack of bonds in this portfolio; it is an all-equity strategy.
This strategy invests 25% each in VFINX, VIMAX, VSMAX, and VTIAX. Rebalance yearly to maintain the 25% weight. Dave Ramsey, much like Warren Buffett, has bullish sentiment on stocks as long-term investments and buying and holding positions for the long-term has been the best strategy for the past 100 years for US stocks in most 10 to 20-year periods. He also likes dollar-cost averaging and getting the full employer 401k match.
6. Bill Bernstein’s No Brainer Portfolio
Author and neurologist turned financial advisor Bill Bernstein devised a simple four-fund index portfolio with 25% in bonds, European stocks, US small cap, and US large cap. The Vanguard version is 25% VBTLX, 25% VEU, 25% VSMAX, and 25% VFINX. The logic is spreading your assets across multiple equity classes and bonds to simplify investing. Rebalance annually to maintain equal weighting.
The benefits of the No Brainer Portfolio include the following:
- Diversification: The portfolio provides broad diversification across different asset classes, reducing the portfolio’s overall risk.
- Simplicity: With only four funds, the No Brainer Portfolio is easy to understand and manage, making it an excellent choice for investors looking for a hands-off investment approach.
- Cost-Effective: Using low-cost index funds or ETFs, the No Brainer Portfolio can be implemented cost-effectively, helping investors minimize fees and maximize returns.
- Potential for Growth: The portfolio offers growth potential by including small-cap stocks and international stocks, which can help boost returns over the long term.
- Risk Management: The allocation to short-term bonds provides stability and helps to mitigate the risks associated with stock market volatility.
- Tilt Toward Value and Small-cap: By dividing the equity portion into large-cap, small-cap, and international stocks, the portfolio has a slight tilt toward value and small-cap stocks, historically providing higher returns than their counterparts.
- Global Exposure: Including international stocks provides exposure to global markets, further diversifying the portfolio and providing additional growth opportunities.
7. Ivy League Endowment Strategy
This model portfolio seeks to copy the endowment funds of Ivy League schools like Harvard and Yale. The Vanguard version is 35% VTSAX, 28% VBTLX, 15% VTIAX, 11% VCMDX, and 11% VGSLX. These substantial endowment funds allocate heavily to alternatives like private equity, but this captures their approach for individual investors. Rebalance yearly.
Using Vanguard funds to replicate the Ivy League Endowment Strategy can bring several benefits. Vanguard is known for its low-cost index funds, which can be advantageous for individual investors who don’t have the same level of resources as university endowments. Here are some of the benefits of using Vanguard funds to implement this strategy:
- Lower Costs: Vanguard is known for its low-cost index funds and ETFs. By using Vanguard funds, you can achieve diversification and exposure to different asset classes without paying high fees.
- Broad Diversification: Vanguard offers a wide variety of funds that can help you mimic the diversification of an Ivy League Endowment Strategy. You can invest in domestic and international equities, fixed income, real estate, and other assets.
- Liquidity: Unlike some alternative investments typically used in endowment portfolios, Vanguard funds are highly liquid, meaning you can buy or sell your investments relatively quickly.
- Transparency: Vanguard funds are transparent. You can easily understand what assets you’re invested in, how the funds are performing, and what fees you’re paying.
- Accessibility: The Ivy League Endowment Strategy often involves investments in alternative assets that are not readily available to individual investors. Vanguard funds allow individual investors to get exposure to similar asset classes without needing large amounts of capital or special access.
- Simplicity: Implementing an endowment strategy with Vanguard funds is more straightforward than trying to replicate the approach with individual securities or less accessible asset classes.
- Tax Efficiency: Vanguard is known for its tax-efficient funds, which can help reduce your tax liability.
- Rebalancing: Vanguard funds make it easier to rebalance your portfolio to your desired allocation, helping maintain your target risk profile.
8. Coffee House Portfolio
Financial author Bill Schultheis’ “Coffee House” portfolio has a slice of everything:
- Large-cap US stocks 10%
- Small-cap US stocks 10%
- International stocks 10%
- REITs (real estate investment trusts) 10%
- Long-term US government bonds 40%
- Short-term US government bonds 10%
- TIPS (Treasury Inflation-Protected Securities) 10%
To build this portfolio with Vanguard funds, you allocate 10% each in VFINX, VVIAX, VSMAX, VSIAX, VGSLX, VTIAX, and 40% in bonds VBTLX. The idea is diversifying across asset classes and factors with a value tilt. The downside is many overlapping funds. Rebalance annually.
- Diversification: The Coffeehouse Portfolio is well-diversified across several asset classes, which can help reduce risk and improve the potential for steady returns over time.
- Simplicity: The Coffeehouse Portfolio uses a straightforward, easy-to-understand, and implemented allocation strategy, making it suitable for new and experienced investors.
- Cost-Effective: By using Vanguard’s low-cost index funds or ETFs to implement the Coffeehouse Portfolio, investors can minimize fees and maximize returns.
- Risk Management: The portfolio includes both stocks and bonds, allowing investors to balance growth potential with risk management. The inclusion of TIPS provides some protection against inflation.
- Global Exposure: By including international stocks, the portfolio provides exposure to global markets, which can further diversify the portfolio and offer additional growth opportunities.
- Real Estate Exposure: The allocation to REITs provides exposure to the real estate sector, offering additional diversification and income potential.
- Tax Efficiency: Vanguard is known for its tax-efficient funds, which can help minimize the impact of taxes on your investment returns.
- Accessibility: Individual investors can quickly implement the Coffeehouse Portfolio easily.
- Consistency: The Coffeehouse Portfolio emphasizes a long-term, buy-and-hold approach, which can help investors avoid the pitfalls of market timing and stay on track toward their financial goals.
9. Ultimate Buy & Hold Portfolio
Investment advisor Paul Merriman created the Ultimate Buy & Hold portfolio with 11 funds diversified across every equity class, including six categories of US stocks, three international, and one bond holding. The complex tactic promises diversity, but rebalancing is a lot of work.
This tactic allocates contributions across 11 funds per Merriman’s framework and rebalances yearly to maintain asset classes aligned.
- 6% – Vanguard S&P 500 Index Fund (VFINX)
- 6% – Vanguard Value Index Fund (VVIAX)
- 6% – Vanguard Small-Cap Value Index Fund (VSIAX)
- 6% – Vanguard Real Estate Index Fund (VGSLX)
- 6% – Vanguard Total International Stock Index Fund (VTIAX)
- 6% – Vanguard International Value Fund (VTRIX)
- 6% – Vanguard International Small-Cap Index Fund (VFSAX)
- 6% – Vanguard International Value Small Cap Fund (Not Available)
- 6% – Vanguard Ultra Small Market Fund (Not Available)
- 6% – Vanguard Emerging Markets Stock Index Fund (VEMAX)
- 40% – Vanguard Short-Term Bond Index Fund (VBIRX)
- Despite many contrasting opinions on asset allocation, no universally “perfect” portfolio exists. Emphasize core principles of diversification, costs, and passive investing.
- More straightforward portfolios like single-fund (100% equities) and two-fund (equities + fixed income) can perform just as well as more intricate tactics if invested steadily over decades.
- Adding asset classes like international equities, REITs, and small caps can provide broader diversification but may overcomplicate rebalancing.
- Sticking with a chosen tactic long-term is critical, rather than frequently reshuffling your portfolio to chase returns.
- Consider your proximity to retirement when deciding bond allocation, as more bonds reduce risk as retirement approaches.
- Index funds provide diversified market returns at low cost. Avoid high-fee actively managed mutual funds.
When constructing an investment portfolio, please keep it simple with passive index funds, diversify prudently based on your goals, select an allocation, and resist tinkering frequently. Consistency, discipline, and minimizing expenses and turnover are the real drivers of long-term returns. No portfolio can predict the future, so choose a sensible tactic you can adhere to over decades.
The key is to choose a tactic and adhere to it long-term rather than constantly changing funds and allocations chasing short-term trends. Simplicity in portfolio construction often prevails over complexity. No portfolio is flawless for every investor. Select the tactic that best aligns with your financial situation, investing philosophy, and maintainability.