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I am new to investing. Currently I'm trying to read about it as much as possible. There is one question that bothers me quite much that I cannot find an answer to, so I decided to ask here.

There is a forumla called CAPM (Capital Asset Pricing Model). It calculates the expected return for a given risk. The formula assumes that I am building a market portfolio (i.e., investing into everything in the world).

And there is the 2004 article called The Capital Asset Pricing Model: Theory and Evidence that says, in particular, that you can "tweak" the portfolio a bit so that the risks would stay the same, but, surprisingly, the expected return would grow comparing to what the CAPM formula predicts. The article says, literally: "funds that concentrate on low beta stocks, small stocks or value stocks will tend to produce positive abnormal returns relative to the predictions of the Sharpe-Lintner CAPM, even when the fund managers have no special talent for picking winners".

The article is also cited in "The Little Book of Bulletproof Investing". The authors of the book suggest to build the next portfolio:

TODO: image

There are 2 concerns:

  1. The book is pretty old already (it's from 2010).
  2. There seems to be no other source that would describe or suggest building such a portfolio (except for the article and the book).

Is it still worth building the portfolio nowadays? Or it's better to invest in an index funds and to not overengineer the problem?

Thank you.

1 Answer 1

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The two ideas are not mutually exclusive. I use a mix of a large-cap index fund, a small-to-medium-cap index fund, a bond index fund, an international index fund, and a REIT index fund to achieve a specific distribution among those kinds of investments. (Not any of the mixes you quote; I've had about four short sessions with a fee-only investment advisor over the past 35 years to tweak the mix to be appropriate for my own risk tolerances and (decreasing, obviously) time horizon.

Average rate of return for my mixes across that timespan is being reported as 8.7% today. Obviously that will swing back and forth to some degree as current market value changes, and no promises about what will happen in the future, but so far it seems to meet my needs.

(Caveat: I'm not sure I entirely believe Quicken's rate-of-return reports. But I'm not about to spend time trying to check them, and whatever it was did the job when combined with income.)

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  • Thank you for your answer! 8.7% looks very close to the S&P 500 average return for the last 30 years (9.90%). Would you mind sharing what percent of your portfolio is invested in the bonds? I'm trying to estimate how much smaller would be the return of a portfolio that contains the same amount of bonds as yours, and the rest is a simple index fund (like S&P 500 or similar).
    – yaskovdev
    Sep 12, 2023 at 21:47
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    I've used two different mixtures over that time -- I readjusted to a slightly more conservative stance when I retired. I do NOT vouch for these being appropriate for anyone or at any time; treat them as example, NOT recommendation. Having said that: For most of that time the mix was 30% bonds, 40% large cap, 8% small cap, 17% international, 5% "income producing" (REIT in my case). And note that I'm considered a moderately aggressive investor, in that I'm willing to wait out most market downturns and recoveries, merely rebalancing occasionally to maintain my intended mix as things move.
    – keshlam
    Sep 12, 2023 at 22:33

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