How to build a lazy portfolio: Difference between revisions
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Lazy portfolios are designed to be indexed portfolios that range from | Lazy portfolios are designed to be indexed portfolios that range from | ||
*For new investors: simple two-fund, [[Three-fund portfolio|three-fund]] , or [[Vanguard four fund portfolio|four-fund]] portfolios built with total market index funds, to | *For new investors: simple two-fund, [[Three-fund portfolio|three-fund]] , or [[Vanguard four fund portfolio|four-fund]] portfolios built with total market index funds, to gain asset diversity. | ||
*For experienced investors: [[Slice and dice|multifactor ("Slice and dice") portfolios]] that contain six or more [[Indexing|index]] funds targeting market, size and value factors. | *For experienced investors: [[Slice and dice|multifactor ("Slice and dice") portfolios]] that contain six or more [[Indexing|index]] funds targeting market, size and value factors. | ||
Lazy portfolios are meant to be buy-hold-and-rebalance portfolios. | Lazy portfolios are meant to be buy-hold-and-rebalance portfolios. |
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Investors are often challenged to select funds from a long list of unfamiliar names. For example, selecting funds for an employer's retirement plan when starting a new job. [footnotes 1]
Alternatively, an investor may know which funds to utilize, but does not understand how to assign the percentage contribution for each fund in the portfolio (see below).
Whether an investor adheres to a philosophy of investing in the total market using a minimum number of funds, or pursues a more advanced strategy of multifactor investing, it is possible to create what's known as a lazy portfolio.
Lazy portfolios are designed to be indexed portfolios that range from
- For new investors: simple two-fund, three-fund , or four-fund portfolios built with total market index funds, to gain asset diversity.
- For experienced investors: multifactor ("Slice and dice") portfolios that contain six or more index funds targeting market, size and value factors.
Lazy portfolios are meant to be buy-hold-and-rebalance portfolios.
Select your asset allocation
The first step when starting an investment program is to choose your asset allocation, basically your allocation to stocks, bonds, and cash. Be sure to consider this in the context of your entire portfolio. When beginning participation in an employer's retirement plan, this means incorporating both the plan investments and your existing investments in your overall allocations. The allocations should reflect your return needs balanced against your tolerance for risk. For most investors this will mean hopefully gaining returns that, in the long run, outpace inflation, while reducing the magnitude of short term investment losses to a level that allows the investor to remain invested without panic selling.
Analyze the fund list
A general checklist when examining fund options:
- For each item in the fund list, find the available asset class exposure that the funds provide and their expense ratios. This information can usually be found in the fund's fact sheets.[footnotes 2]
- The general approach for total market investors is to look for the major categories, such as US stock, international stock, US bonds, and international bonds. Fixed income (cash reserves) counts as bonds; company stock funds count as stock. Some bond funds may be listed as "inflation protected." [footnotes 3]
- Investors desiring to create multifactor portfolios will want to also find funds (optimally indexed) that provide exposure to small cap and value stocks in both US and international markets.
- For asset allocations, it's only necessary to get the percentages to the nearest 5 %.
Target date retirement funds
The default option for employer provider plans is to place your contributions and employer matches into a target date retirement fund. If you are a novice investor and the process of selecting funds is too complicated, then staying with a target date retirement fund may be entirely suitable for you. Select the fund which matches your desired asset allocation.[footnotes 4]
However, many retirement date funds use a large number of actively managed funds. If these funds are available at a modest expense ratio, this may be a satisfactory option. but you need to carefully check the underlying funds to see if they truly match your desired allocation. [footnotes 5]
An advantage of tax-deferred accounts is that you can transfer among the different funds without paying taxes on the gains. In other words, you are not stuck with this decision. There is no penalty for changing your mind later. If you feel more confident about lowering your expenses by going to separate low-cost funds at a later time, you are free to do so.
Select the funds
The first step in fund selection within your employer retirement plan is to look for choices that have the word "index" in them, such the "SSgA S&P 500 Index" fund or "SSgA US Bond Index" (US Bonds) or "SSgA Global Equity Ex US Index" (there may be an alphabet soup of acronyms here, such as MSCI EAFE. The asset allocation information will tell you what this fund is for, i.e. international stock). Index funds will generally be your lowest cost funds.
An actively managed fund ("index" is not in the fund name) will generally have higher costs than an equivalent index fund.
Employer provided plans typically contain at least one or two index funds. Some plans may have a brokerage window that provides access to a wider selection of indexed investment options.
If your plan provides no index funds select the lowest cost funds for stock fund choices and select the highest grade bond funds. [footnotes 6]
If you are looking to build a multifactor portfolio, and you do not have small cap and value index funds available in the employer plan, look for a total market or S&P 500 index fund for market factor exposure, and use other accounts for small cap and value factor exposure. The plan may also contain suitable bond funds for filling bond allocation requirements.
U.S. stocks
If you are a total market investor you may not be able to approximate the total stock market with the available choices, but do the best you can. An S&P 500 index fund should be adequate on its own if you can't find (or don't want the added complexity of) small-cap and mid-cap funds.
A completion index fund can be used to complement an S&P 500 fund. These two funds will provide exposure to the total US stock market.
A multifactor investor may not have small cap and value index funds in the employer provided plan. The investor may need to place these allocations in personal retirement plans or taxable accounts.
Select the allocation percentages
Now that the funds have been identified, you must determine how much of a percentage to assign to each fund. The following two examples show how one might make these allocations.
Total market investors
This approach is intended for new investors who would like the simplicity of managing only a few funds while investing in the total market - a Bogleheads' approach to managing your portfolio. |
Target date retirement funds can provide a model for your portfolio since they are nothing more than lazy portfolios managed by investment professionals. Your decision is to simply align your desired asset allocations with the appropriate target retirement fund.
For example, if you are a three-fund or four-fund investor and would like an asset allocation of 60% stocks / 40% bonds and find Vanguard's target retirement funds list a suitable guide, the Vanguard Target Retirement 2020 Fund (VTWNX) is likely close to what you are looking for. Under Portfolio and Management:
Vanguard Target Retirement 2020 Fund (VTWNX) Asset Allocation as of August 31, 2013 Ranking by Percentage Fund Percentage Round to the nearest 5% 1 Vanguard Total Stock Market Index Fund Investor Shares (US Stocks) 43.6% 40% 2 Vanguard Total Bond Market II Index Fund Investor Shares (US Bonds) 30.3% 30% 3 Vanguard Total International Stock Index Fund Investor Shares (International Stocks) 18.5% 20% 4 Vanguard Total International Bond Index Fund Investor Shares (International Bonds) 7.6% 10% Total — 100.0% 100%
- 60% Stocks = 40% US Stocks + 20% International Stocks
- 40% Bonds = 30% US Bonds + 10% International Bonds
If you don't have international bonds, just combine it with the total bonds.
Replace the Vanguard fund names with your selections (rounded to the nearest 5%) and your three-fund or four-fund portfolio is complete.
Inflation-protected securities
Bond funds identified as inflation-protected, like TIPS, are somewhat different than a conventional bond fund. Their purpose is to help diversify your portfolio further by providing some protection against inflation.[footnotes 7]
One Boglehead approach is to add inflation-protected securities to the bond portion of your portfolio, perhaps up to 50% of the bond allocation. The choice is arbitrary - from not using any inflation-protected fund up to 50% (or more). The decision is based on a level of comfort (can you sleep well at night) rather than one based on theory.
Multifactor ("slice and dice") investors
This approach is intended for experienced investors, as it intentionally deviates from investing in the total market - a Bogleheads' approach to managing your portfolio. |
Using the Coffeehouse Portfolio as a template for a sample multifactor portfolio and utilizing Vanguard funds for a 60% stocks / 40% bonds allocation, you might allocate a portfolio as follows:
Ranking by Percentage | Fund | Percentage |
---|---|---|
1 | Vanguard Intermediate-Term Bond Index Investor Shares (US Bond | 40.0% |
2 | Vanguard Large Cap Index Investor Shares (US Stocks) | 10.0% |
3 | Vanguard Large Cap Value Index Investor Shares (US Stocks) | 10.0% |
4 | Vanguard Small Cap Index Investor Shares (US Stocks) | 10.0% |
5 | Vanguard Small Cap Value Index Investor Shares (US Stocks | 10.0% |
6 | Vanguard REIT Index Investor Shares (US Stocks) | 10.0% |
7 | Vanguard Total International Index Investor Shares (International Stocks | 10.0% |
Total | — | 100.0% |
Select whichever asset class indexed funds are available in the employer retirement plan to fill these allocations and use other accounts to fill out the allocation.
Multiple accounts
If you are married, a frequently encountered situation is that the investment portfolio is allocated to a multiplicity of accounts. For example, a husband and wife may both have employer provider plans, both have personal retirement plans, both have taxable accounts. This equals six accounts. [footnotes 8] For guidance on handling these more complex scenarios, see Asset allocation in multiple accounts.
Notes
- ↑ A listing of 401-k options from Portfolio help with a tricky 401k, forum discussion
401-k options Fund Expense ratio Bond funds AST Galliard Retirement Income Class 35 0.63% Pimco Total Return Instl (PTTRX) 0.46% Pimco Real Return Instl (PRRIX) 0.45% Templeton Global Bond Adv (TGBAX) 0.65% Stock funds Invesco Growth & Income R5 (ACGQX) 0.47% Vanguard Institutional Index Instl (VINIX) 0.04% Mainstay Large Cap Growth Instl (MLAIX) 0.79% Jpmorgan Mid Cap Value I (FLMVX) 0.76% Prudential Jennison Mid Cap Growth Z (PEGZX) 0.76% Columbia Small Cap Value Ii Z (NSVAX) 1.06% William Blair Small Cap Growth I 1.25% - ↑ Hint: Put everything in a spreadsheet. It's easier to make updates and will help when calculating percentages and fund amounts later on.
- ↑ For example, Forum discussion 401k investment offers the options displayed in the table below:
401-k investment options Fund Expense ratio Target date funds Vanguard Target Retirement Income Fund 0.16 Vanguard Target Retirement Fund 2010 0.16 Vanguard Target Retirement Fund 2015 0.16 Vanguard Target Retirement Fund 2020 0.16 Vanguard Target Retirement Fund 2025 0.17 Vanguard Target Retirement Fund 2030 0.17 Vanguard Target Retirement Fund 2035 0.18 Vanguard Target Retirement Fund 2040 0.18 Vanguard Target Retirement Fund 2045 0.18 Vanguard Target Retirement Fund 2050 0.18 Vanguard Target Retirement Fund 2055 0.18 Vanguard Target Retirement Fund 2060 0.18 Balanced fund Steelcase Balanced 0.36 US stock funds Steelcase General 0.32 Steelcase Long-Term Growth 0.38 Vanguard Windsor II - Admiral 0.27 SSgA S&P 500 Index SL-XII 0.03 PRIMECAP Odyssey Growth 0.67 American Beacon Small Cap Value-Inst 0.92 Vanguard Extended Market Index-Inst 0.12 Eagle Small Cap Growth-R6 0.69 American Funds New Perspective-R6 0.46 International stock funds SSgA Global All Cap Equity ex US Index NL-C 0.40 Templeton Inst Foreign Equity-Primary 0.80 Bond funds NT Collective Aggregate Bond Index-Tier 1 0.07 Wells Fargo Stable Return 0.43 Western Asset Core Plus Bond Fund-I 0.46 In this instance, the investor has the option of selecting a lazy portfolio of indexed target retirement funds or fashioning a lazy portfolio from the following stand-alone index funds:
Fund Expense ratio SSgA S&P 500 Index SL-XII 0.03 Vanguard Extended Market Index-InstExample 0.12 SSgA Global All Cap Equity ex US Index NL-C 0.40 NT Collective Aggregate Bond Index-Tier 1 0.07 - ↑ Don't pick a fund by the retirement date, as the chosen level of risk (asset allocations) may not match your intentions. Ignore the date and use the asset allocations instead.
- ↑ For example, Fidelity Freedom 2035 Target Date fund employs 24 actively managed funds as the underlying investments for the fund (see Analyze the Fidelity Freedom 2035 Fund (FFTHX) composition). American funds employ 17 active funds in its target fund. T. Rowe Price uses 17 active funds and one index fund in its 2035 fund.
- ↑ For example,
401k Choices Seem Expensive, forum discussion reveals a 401-k plan offering only active funds.
401-k options Fund Expense ratio Bond funds American Funds Bond Fund of Amer R4 RBFEX 0.60% BlackRock High Yield Bond Inv A BHYAX 1.01% Target date JPMorgan SmartRetirement 2010 A JSWAX 1.17% JPMorgan SmartRetirement 2015 A JSFAX 1.20% JPMorgan SmartRetirement 2020 A JTTAX 1.24% JPMorgan SmartRetirement 2025 A JNSAX 1.28% JPMorgan SmartRetirement 2030 A JSMAX 1.32% JPMorgan SmartRetirement 2035 A SRJAX 1.36% JPMorgan SmartRetirement 2040 A SMTAX 1.39% JPMorgan SmartRetirement 2045 A JSAAX 1.41% JPMorgan SmartRetirement 2050 A JTSAX 1.43% JPMorgan SmartRetirement 2055 A JFFAX 1.39% Balanced Funds American Funds Capital Inc Bldr R4 RIREX 0.66% American Funds Inc Fund of Amer R4 RIDEX 0.65% US Large Cap Funds American Funds Fundamental Investors R4 RFNEX 0.66% American Funds Growth Fund of Amer R4 RGAEX 0.69% American Funds Invmt Co of America R4 RICEX 0.65% American Funds Washington Mutual R4 RWMEX 0.65% BlackRock Equity Dividend A MDDVX 0.99% US Mid Cap Funds Dreyfus Structured MidCap I DPSRX 1.22% Ivy Mid Cap Growth Y WMGYX 1.30% RidgeWorth Mid-Cap Value Equity I SMVTX 1.07% Small Cap Funds Delaware Small Cap Value A DEVLX 1.37% ClearBridge Small Cap Growth A SASMX 1.32% PIMCO Small Cap StocksPLUS AR Strat A PCKAX 1.19% International Funds American Funds EuroPacific Gr R4 REREX 0.85% American Funds New Perspective R4 RNPEX 0.81% American Funds SMALLCAP World R4 RSLEX 1.08% Virtus Emerging Markets Opportunities A HEMZX 1.57% In this instance, an investor could minimize costs and fashion a three fund portfolio of large cap US stocks, developed market international stocks, and an investment grade intermediate bond fund:
Fund Expense ratio American Funds Invmt Co of America R4 RICEX 0.65% American Funds EuroPacific Gr R4 REREX 0.85% American Funds Bond Fund of Amer R4 RBFEX 0.60% - ↑ Inflation-protected securities actually protect against unexpected inflation, which is not discussed here.
- ↑ In addition to the doubling of marital investment accounts (employer provided retirement accounts, personal retirement accounts, and taxable accounts), it is possible to have even more potential accounts. These additional accounts may include:
- Supplemental employer retirement plans , such as a 457-b plan.
- Inherited non-spousal IRAs, which, by law, cannot be mingled with other IRA accounts.
- Health savings accounts.
- Fixed or variable deferred annuities.
- College savings plans, such as a 529 plan or a Coverdell Education Savings Account.
- A charitable remainder trust or a charitable pooled income fund.