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The book 'The Intelligent Investor' defines 'defensive portfolio' as one that holds, at least, 50% of bonds and 50% of stocks, being it more defensive as the proportion of bonds increases.

However, (correct me if I'm wrong) the book doesn't specify the kind of stocks that such portfolio holds.

As far as I can see, if the portfolio holds stocks of 10 startups with a very high risk and grow potential, it could make sense to hold bonds to compensate such risk. On the other hand, if the portfolio only holds an ETF that tracks the S&P 500, that's a completely different situation, and might be 'safe' enough without the need for bonds.

My question is: according to 'The Intelligent Investor', would a portfolio made exclusively of index funds/ETFs that track S&P 500 (or similar), be considered defensive?

  • The whole book is about which stocks you should consider buying. – xyious Nov 18 '19 at 20:02
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Let's take a look at a bit of modern portfolio theory and efficient market hypothesis.

According to modern portfolio theory, there are individual assets that vary based on risk and return. From these, you can construct an optimal portfolio. It's the one that is on the efficient frontier, and is called "tangency portfolio" because it's the portfolio that is tangent to the line between risk-free asset and the optimal portfolio.

The best possible capital allocation line is between a risk-free asset and this tangency portfolio. You can construct any portfolio in this line by holding the tangency portfolio and the risk-free asset in desired quantities. Sometimes, if looking for high risk, that means borrowing money at the risk-free rate and investing the borrowed money into the tangency portfolio. So, in that case, you have a negative position in the risk-free asset.

This two mutual fund theorem means that holding two funds in desired proportions can construct any portfolio in the optimal allocation line. Adding more than two funds in unnecessary.

I haven't read the book "The Intelligent Investor", but when referring to stocks, it almost certainly is referring to the tangency portfolio constructed from individual stocks.

If you add the efficient market hypothesis, you will see that the tangency portfolio is indeed the index!

You can also see that the risk-free asset is government bonds.

So, by holding a portfolio of stock market index and government bonds, you can construct any optimal portfolio in the risk-return space. That's very nice to know. There are countless mutual funds, but you can pick only two: a low-cost government bond fund, and a low-cost internationally diversified stock market index fund.

As a warning: the S&P 500 is not the tangency portfolio because it lacks international diversification. Something like MSCI World would be very close to the tangency portfolio.

My question is: according to 'The Intelligent Investor', would a portfolio made exclusively of index funds/ETFs that track S&P 500 (or similar), be considered defensive?

No. The defensive portfolio is referring to 50% risk-free asset (government bonds) and 50% tangency portfolio / internationally diversified stock market index.

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