It’s time for another bi-monthly update on my investment portfolio.

Thoughts
Another two months with little activity in my low-maintenance portfolio. I don’t get the joy of reading about my fund picks in magazines, but I don’t worry about choosing the wrong one either.

I am still ironing out a slightly tweaked asset allocation, one that has a more balanced domestic/international distribution and something I hopefully won’t mess with again for a long time. I’m reviewing the model portfolio comparisons and the books they came from, including Ferri’s new book All About Index Funds.

You can see some older posts on how this portfolio came to be here, as well as my previous portfolio snapshots here.

All of these suggested portfolios were developed by smart people who did their homework. But none of them are the same! This is because every single one also made compromises based on their interpretation of current research, simplicity, availability of suitable investments, costs, and also to some measure their overall predictions of the future. We have to do the same thing on our end.

For example, many people are starting with smaller amounts. Some of these model portfolios have 8 funds or more! Just by the fund minimums alone, you’d be looking at a minimum balance of $24,000 or so. And even then, you’d be looking a various low balance and maintenance fees. So what do you to minimize fees? Here are a few ideas:

1) Buy an all-in-one fund, and split it up later. Since many fund companies have all-in-one target-dated funds, you can simply buy one of these until you have enough to split into other funds. Here are some specific fund suggestions, starting at only $50 per month. The fund’s asset allocation may not be exactly what you want, but it will be well-diversified, and still much better than other high-cost alternatives. Here’s what the Vanguard Target 2045 Fund looks like:

I built up about $50,000 in Vanguard Target funds (VTIVX and VTTHX) before splitting it up into 8 funds last year. Since they were held in IRAs/401ks, I didn’t have to worry about any tax consequences. This choice is my favorite because it’s the most simple – just buy the same fund for a few years!
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(This is the fifth in my series of Model Portfolio Comparisons.)

First written in 1973, Burton Malkiel’s A Random Walk Down Wall Street (my review) has become an investing classic, pioneering the controversial idea that stock prices are random and thus a monkey throwing darts would be just accurate as any stock-picker. Below is a recommended asset allocation from the book for an investor in their “mid-twenties”.

Bold Investor Model Portfolio

Asset Allocation for suggested 75% Stocks/25% Bonds ratio
43% Total US Stock Market
22% Total International Stock Market
10% REIT
20% Treasuries/TIPS/High-Quality Corporate Bonds
5% Cash

This breakdown looks very similar to the basic “Early Saver” portfolio from All About Asset Allocation. See the rest of the model portfolios for example mutual funds and ETFs for each asset classes.

As you age, the recommended percentage of stocks goes down to 65% at age 40 and 40% in late retirement. It is interesting to note that while Malkiel consistently recommends real estate as part of your portfolio, REITs were not explicitly included in the recommended portfolios until recently. I noticed this when comparing my personal copy (published in 1996) to the most recent edition. I’m guessing the growing availability of index funds that track REITs is the reason behind this.

(This is the first in my series of Model Portfolio Comparisons.)

The Couch Potato Portfolio is the invention of Scott Burns, a personal finance columnist at the Dallas Morning News. Originally, the portfolio consisted of just two funds – the Vanguard S&P 500 Index Fund (VFINX) and the Vanguard Total Bond Index Fund (VTBMX). That was over 15 years ago, and it has beaten most balanced funds in the meantime. The current version is below.

Asset Allocation (All Ages)
50% Total US Stock Market
50% US Inflation-Indexed Securities.

There are many ways that people find fault with this portfolio – low stock allocation, no risk adjustment with time, no international exposure, no REIT fund. Partially in response to these, Burns has also introduced other variations like the Margarita Portfolio and Four Square Portfolio. The Margarita Portfolio is 33% Total US Stock Market, 33% Total International Stock Market, and 34% Inflation Protected Securities. But still, you can’t beat the simplicity.

In my rough guide to investing, I suggested some all-in-one mutual funds for beginners. But what if you want to go a step further and design your own portfolio? Or you have a 401k with only limited choices?

Of course, the best answer is always to read some good books. But another idea I’ve been meaning to do for a while is to collect the model portfolios from lots of different reputable books and sources and compare them to each other. You won’t see any individual stock picks here, all the sources will be based (at least loosely) upon modern portfolio theory and thus focus on optimizing the risk/reward ratio using proper asset allocation.

I think it should go without saying that since these are model portfolios, they are imperfect by design and at most should serve as rough guidelines for your own investing. Everyone has a different time horizons and situations. Use them as one part of your own research.

One way to tailor these portfolios to your own use is to adjust the stock/bond ratio according to how aggressive you wish to be. Accordingly, I have tried to separate the stock and bond components.

Completed Model Portfolios

1. Couch Potato Portfolio
2. Boglehead’s Guide To Investing
3. All About Asset Allocation
4. The Intelligent Asset Allocator
5. A Random Walk Down Wall Street
6. FundAdvice.com by Merriman
7. Unconventional Success by Swensen
8. Columnist Ben Stein

Future Model Portfolios (in progress)

Here are the remaining sources that I have in mind so far. Please feel free to suggest others.

• The Four Pillars of Investing by Bernstein (Review)
• Common Sense on Mutual Funds by Bogle (Review)
• The Informed Investor by Armstrong (Review)
• Index Funds: The 12-Step Program for Active Investors by Hebner (Review)
• Coffeehouse Portfolio by Schultheis

This index of posts has been added to my Rough Guide To Investing.

Dollar Cost Averaging (DCA) involves investing a fixed amount at a regular interval. Lump-Sum Investing (LSI) involves putting in all the money you have available to invest at once. These are not mutually exclusive! If you are investing a portion of your paycheck every month, you are both Dollar Cost Averaging and Lump Sum Investing. The following is not about such habitual savings.

However, a different situation arises if you have a larger amount of money. Maybe you received an inheritance, an early retirement payout, or you just sold your house. Do you invest the entire amount immediately, or buy a little at a time? Due to the overall upward trend of the markets, lump-sum investing outperforms DCA about 2/3rd of the time. The argument then, is that DCA is a risk-reduction mechanism; You get less performance, but also less exposure to those ups and downs. But is DCA the best way to lower risk?

This question was examined in this academic paper titled Nobody Gains from Dollar Cost Averaging by Knight and Mandell. Here’s a sample of their results. Let’s say you have $100,000 to invest, and you want to achieve a portfolio of 90% stocks (modeled as the S&P 500) and 10% bonds (T-Bills). But that sounds risky to you. You decide to instead invest gradually over 10 years, every month putting a little bit more in, until you finally put $90,000 into stocks.

But what if you instead put everything at once into 50% stocks and 50% bonds, and kept those 50/50 proportions for the entire 10 years instead? That would also reduce your risk. You may be surprised to find out that historically the 50/50 rebalanced portfolio actually had the same amount of volatility than the 90/10 dollar cost averaged portfolio, but with a higher average return (8.37% vs. 8.05%).

So if you are keeping money out of the market because you don’t want to be exposed to a crash, it may simply be better to invest in a less aggressive investment mix. But if you are already regularly investing what you can each month, keep it up! This doesn’t apply to you.

For more academic papers on why DCA is not the best way to reduce risk, see this AltruistFA reading list. Thanks to reader Craig for sending me this article.

For my overall thoughts on investing for beginners, please see my Rough Guide to Investing.

Now how about a snapshot of our investments, as of the end of the day 12/15. Remarkably, our investments have increased $4,911 (7.3%) since my last update in October. Another example of how I can’t predict the stock market. We’re already done contributing to our Roth IRAs and 401ks this year, so we haven’t made any new deposits. Everything has been going into the house down payment fund.

I did realize that I’m not including my Bridgeway investments in my net worth calculations. This is because Bridgeway does not work with Yodlee, and I never remember to log into their website. Oops!

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(Note: This is an older post from my archives, and was last revised in 2007, so some things may be out of date. Please check out my investing guide for more recent material.)

Although I get asked regularly to do so, I’m always wary of making specific investment advice . I’m haven’t passed any securities exams, and I have no financial letters after my name like CFA, CFP, CIC, or ChFC. I’m just a SRDO – Some Random Dude Online.

At the same time, I also appreciate the fact that people like to hear some specific suggestions in order to jumpstart their own research. It’s like being told “go buy a good used car” versus “check out the 2002-2004 Honda Civic (7th Generation, but not the 1st year) with less than 60,000 miles on it.” It’s not the perfect answer for everyone, and you may not even buy that car, but it gives you something to work with.

With that in mind, this is what I would tell my sister to invest. Not you, because I don’t know you. 🙂 She’s in her early 20s, recently out of college, working in her first professional job, and trying to balance renting in a big city, being young and trendy, paying back student loans, and oh yeah! – also retirement. She’s busy, doesn’t feel like reading the books I recommend just yet, but has some extra money now to put away for the future. So what does big bro tell her?

Get investing! You need to do this now so you can:

1. Reduce your risk in the long run
2. Get used to the ups and downs of the stock market (so you don’t just bail out later).

Option 1: No Money Down?
Set Up An Automatic Transfer at TIAA-CREF or T. Rowe Price

If she’s doesn’t have much to start with but is willing to set aside $50 every month, you can open an account at T. Rowe Price or TIAA-CREF with no initial investment minimum. If you’re in your 20s, look at the T. Rowe Price Retirement 2045 fund (TRRKX) or TIAA-CREF Lifecycle 2040 (TCLOX). Both seem to be solid companies with good customer service. They will get you “in the game”, are very low-maintenance, and will leave you with plenty of time to refine your tastes afterwards.

The good thing about starting low is you’ll get gradual exposure to the volatility of the market. In the beginning, it took me a while to get used to the fact that my balance could easily be much lower than it was yesterday. That can be very disconcerting for those only used to bank accounts.

Option 2: Think Long Term
Open Up An Account at Vanguard

I make no secret that I really like Vanguard. They have reliably low expenses, are fair and upfront about their fees and how they are compensated, and they are client-owned. Although they may have some higher fees in the beginning, I believe that over the long run their low expenses and indexing-expertise will result in superior performance. This is a company that I can see sticking with for the next 50+ years. So here’s one strategy using Vanguard for any account size:

Less Than $1000 – If she has less than $1,000, I’d tell her to just stick it in a high-yield savings account. Set up some automatic transfers from her checking account after each paycheck, and start building that up until you have…

$1000-$3,000 – Here, the only fund that’s available is the Vanguard STAR Fund (VGSTX). You can open up with $1,000 to start and add in $100 more at a time. It’s an okay fund, currently with 63% stocks, 25% bonds, and 12% cash. The point isn’t to get the perfect asset allocation right away, it’s to get get started. Again, see the two main goals above.

$3,000+ – When you get to this amount, exchange your shares into the Vanguard Target Retirement 2045 Fund (VTIVX). Since it’s in an IRA, there are no tax consequences or paperwork to worry about. See my post comparing Vanguard and T. Rowe Price Target funds for why I like it the best.

For all Vanguard IRAs, there is a fee of $10 a year for each fund account with a balance of less than $5,000 (waived with high overall balances). Use the $10 as a specific savings goal – “I will eat out one less time this week, saving $10”. Then write Vanguard a check for the $10 separately, so it’s not taken out of your Roth IRA balance. You want all that money compounding away! These fees are now waived with e-statements!

With all of these options, it is always a good idea to set up automatic transfers to avoid the “I forgot again because I was busy” factor. Also, feel free to call any of these companies on the phone. You should get a helpful human quickly, I always do with Vanguard.

Anyways, I hope these suggestions provide some good starting points for your own research. I sure hope my sister listens to me! As always, comments are welcome.