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Is the Yale Portfolio by David Swenson:

http://www.etftopics.com/yale-etf-portfolio/

Too conservative for a twenty-something with a mid-sized portfolio (under $100K)? What are some of the pro's and con's?

  • Why are you asking if it's too conservative? Do you mean "is it prudent?" – mbhunter Sep 29 '10 at 4:16
  • Sure, if that can get you to answer the question :) – Sheehan Alam Sep 29 '10 at 5:43
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    That depends on your risk tolerance. If you already have $100,000 saved at 25 with plenty more on the way (and are single without any kids or mortgage) then you probably can afford to lose that money, so you can take lots of risks to make it grow more. – fennec Sep 30 '10 at 16:31
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You can look the Vanguard funds up on their website and view a risk factor provided by Vanguard on a scale of 1 to 5. Short term bond funds tend to get their lowest risk factor, long term bond funds and blended investments go up to about 3, some stock mutual funds are 4 and some are 5.

Sector                                      % of Fund       Fund    Risk Factor
Total Market Index                          30%             VTSMX   4
Total International Stock Index Fund        20%             VGTSX   5
REIT index                                  20%             VGSIX   4
U.S. Treasury Bond Index                    15%             VFISX   1
TIPS Bond Index                             15%             VIPSX   2

Note that in 2008 Swenson himself had slightly different target percentages out here that break out the international stocks into emerging versus developed markets.

So the average risk of this portfolio is 3.65 out of 5. My guess would be that a typical twenty-something who expects to retire no earlier than 60 could take more risk, but I don't know your personal goals or circumstances.

If you are looking to maximize return for a level of risk, look into Modern Portfolio Theory and the work of economist Harry Markowitz, who did extensive work on the topic of maximizing the return given a set risk tolerance. More info on my question here. This question provides some great book resources for learning as well.

You can also check out a great comparison and contrast of different portfolio allocations here.

3

I don't think the advice to take lots more risk when young makes so much sense. The additional returns from loading up on stocks are overblown; and the rocky road from owning 75-100% stocks will almost certainly mess you up and make you lose money. Everyone thinks they're different, but none of us are.

One big advantage of stocks over bonds is tax efficiency only if you buy index funds and don't ever sell them. But this does not matter in a retirement account, and outside a retirement account you can use tax-exempt bonds.

Stocks have higher returns in theory but to have a reasonable guarantee of higher returns from them, you need around a 30-year horizon. That is a long, long time.

Psychologically, a 60/40 stocks/bonds portfolio, or something with similar risk mixing in a few more alternative assets like Swenson's, is SO MUCH better. With 100% stocks you can spend 10 or 15 years saving money and your investment returns may get you nowhere. Think what that does to your motivation to save. (And how much you save is way more important than what you invest in.)

The same doesn't happen with a balanced portfolio. With a balanced portfolio you get reasonably steady progress. You can still have a down year, but you're a lot less likely to have a down decade or even a down few years. You save steadily and your balance goes up fairly steadily. The way humans really work, this is so important.

For the same kind of reason, I think it's great to buy one fund that has both stocks and bonds in there. This forces you to view the thing as a whole instead of wrongly looking at the individual asset class "buckets." And it also means rebalancing will happen automatically, without having to remember to do it, which you won't. Or if you remember you won't do it when you should, because stocks are doing so well, or some other rationalization.

Speaking of rebalancing, that's where a lot of the steady, predictable returns come from if you have a nice balanced portfolio. You can make money over time even if both asset classes end up going nowhere, as long as they bounce around somewhat independently, so you'll buy low and sell high when you rebalance.

To me the ideal is an all-in-one fund that aims for about 60/40 stocks/bonds level of risk, somewhat more diversified than stocks/bonds is great (international stock, commodities, high yield, REIT, etc.). You can just buy that at age 20 and keep it until you retire.

In beautiful ideal-world economic theory, buy 90% stocks when young. Real world with human brain involved: I love balanced funds. The steady gains are such a mental win.

The "target retirement" funds are not a bad option, but if you buy the matching year for your age, I personally wish they had less in stocks.

If you want to read more on the "equity premium" (how much more you make from owning stocks) here are a couple of posts on it from a blog I like:

Update: I wrote this up more comprehensively on my blog,

1

That looks like a portfolio designed to protect against inflation, given the big international presence, the REIT presence and TIPS bonds.

Not a bad strategy, but there are a few things that I'd want to look at closely before pulling the trigger.

  • REITs can be good hedge against inflation, but some REITs are all about new construction, and others carry heavy debt burdens that require refinancing later. The problem is, inflation brings higher interest rates, which will hurt these kinds of REITs.
  • REITs often have preferred share classes with more favorable treatment or other weird attributes that can hurt you. I suspect that a Vanguard fund would insulate you from this, but you should make sure that you understand what you're buying.
  • Look for the concentration of investments in the international fund that you choose. International stocks change in value due to the underlying securities AND exchange rates. That's why they are a higher risk -- you need to be willing to deal with wide swings in value without freaking out! My 401k international exposure is MGEMX... a fund that has treated me well, but which is also a real roller coaster!
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I think Swenson's insight was that the traditional recommendation of 60% stocks plus 40% bonds has two serious flaws:

1) You are exposed to way too much risk by having a portfolio that is so strongly tied to US equities (especially in the way it has historically been recommend).

2) You have too little reward by investing so much of your portfolio in bonds.

If you can mix a decent number of asset classes that all have equity-like returns, and those asset classes have a low correlation with each other, then you can achieve equity-like returns without the equity-like risk.

This improvement can be explicitly measured in the Sharpe ratio of you portfolio. (The Vanguard Risk Factor looks pretty squishy and lame to me.)

The book the "The Ivy Portfolio" does a great job at covering the Swenson model and explains how to reasonably replicate it yourself using low fee ETFs.

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