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This is a question about "Personal investing and asset allocation".

About me:

  • I earn more than I spend
  • I may retire in 15 or 20 years, and I have savings to be invested in something or managed somehow until then
  • I'm a computer programmer with a Math degree, but I'm not a finance professional/expert

In the past, people have encouraged me to invest in 'mutual funds', and I haven't been impressed with the result: I was invested during the dot-com crash, and again during the downturn of a year or two ago, and found that the supposedly 'managed' mutual funds still lose value during a down-turn (which is disappointing) and also don't go up as much as the ordinary stock market index during an upturn (also disappointing).

So I was wondering about something different: index funds, instead of mutual funds. Preferably low-cost, and diversified; and possibly small-cap, if those have a better-than-average yield.

Is something like the "The Über–Tuber" listed at the bottom of http://canadiancouchpotato.com/model-portfolios/ a sensible investment choice for me? What should I beware of, and what's the disadvantage of that as a strategy?

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I think you're on the right track with that strategy. If you want to learn more about this strategy, I'd recommend "The Intelligent Asset Allocator" by William Bernstein.

As for the Über–Tuber portfolio you linked to, my only concern would be that it is diversified in everything except for the short-term bond component, which is 40%. It might be worth looking at some portfolios that have more than one bond allocation -- possibly diversifying more across corporate vs government, and intermediate vs short term. Even the Cheapskate's portfolio located immediately above the Über–Tuber has 20% Corporate and 20% Government.

Also note that they mention:

Because it includes so many funds, it would be expensive and unwieldy for an account less than $100,000.

Regarding your question about the disadvantages of an index-fund-based asset allocation strategy:

  • It requires discipline to execute. If you let your actual allocation stray too far from the target allocation, you don't get all of the advantages of diversification.
  • If you select the wrong allocation you can end up with poor performance. As a rough general rule, the more poorly correlated assets you assemble into your portfolio, the lower risk you can expect for a given expected return.
  • Discipline again: if one of your assets takes a dive and you panic, sell, and let the money sit in cash, then you lose out on gains when that asset recovers in price. It takes experience and discipline to be able to buy stocks during times like November 2008 or October 2001.
  • Thank you for your reply. Why is there a short-term bond component at all: is it just to dilute the variation (the risks and gains)? Would putting the 40% in 'GICs' be as good or better? Or are bonds actively the opposite of stocks (bonds go up when stocks go down, and vice versa)? Why does it (and/or, would you) recommend 'short-term' bonds? According to its index (which is visible online) "The Intelligent Asset Allocator" doesn't include many pages about bonds: is there an introduction to bonds that you can recommend to me? – ChrisW Apr 24 '11 at 1:46
  • "I think you're on the right track with that strategy" - It sounds like a plausible strategy to me. But then again "invest in a mutual fund to benefit from professional fund managers" also sounded plausible at the time: so I'm a little suspicious of what's "plausible". Is there a counter-argument, is there a potential downside to the strategy, a scenario in which it could fail? What are the risks, is there something to beware of, what due diligence should I attempt before I buy? – ChrisW Apr 24 '11 at 2:25
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    Call me a market-timer if you must, but... it's Q2 of 2011, interest rates are still pathetic, everyone and their dog (e.g. WalMart) is crying "inflation ahead!" and even Bernanke is thinking about considering raising interest rate targets eventually. Long-term bonds might not be the place to be under these circumstances. Just sayin'. Otherwise, general agreement here. – fennec Apr 24 '11 at 18:39
  • @fennec: I'd agree. I couldn't really recommend buying long term bonds right now, but an intermediate-term index with maybe a 4-5 year duration wouldn't be too bad. – bstpierre Apr 24 '11 at 23:08
  • @ChrisW: Sorry, I don't have any good bond references to recommend. FWIW, that book doesn't really talk in depth about any particular asset class -- they're all treated as sort of abstract concepts, where bonds, stocks, REITs, etc are simply things you can buy that tend to appreciate in value over time. It does discuss some of the different kinds of bonds and how they each behave as an asset class relative to one another: short, intermediate, long; government vs corporate; high yield. It gets into a discussion of duration. – bstpierre Apr 24 '11 at 23:34
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You can simply stick with some index funds that tracks the S&P 500 and Ex-US world market. That should provide some good diversification. And of course, you should always have a portion of your money in short/mid term bond fund, rebalancing your stock/bond ratio all the way as deemed necessary.

If you want to follow the The Über–Tuber portfolio, you'd better make sure that there's minimum overlapping among the underlying shares that they hold.

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