A word for the naive: Well done!

One of the duties on the long list of grownup responsibilities is to figure out how much money to put into your company’s 401(k) offerings. Many people, rather than figuring out their long-term goals and tolerance for risk, simply split their money equally between all the options.

This is known as the 1/n portfolio among the nerdly, or more generally, the naive portfolio. And its results generally aren’t that bad, even when compared with high-powered optimized portfolios.

What makes the naive portfolio more interesting is that companies don’t choose their 401(k) offerings much differently than naive investors do: That is, they tend to offer very large funds with a good near-term track record. The odds are good that your fund’s 401(k) offerings are simply the largest funds available. Here are the 10 largest mutual funds, ranked by assets, and how they performed last year.

Name Ticker Morningstar Category 2017 gain
Vanguard Total Stock Mkt Idx Inv VTSMX US Fund Large Blend 21.05%
Vanguard 500 Index Investor VFINX US Fund Large Blend 21.67%
Vanguard Total Intl Stock Index Inv VGTSX US Fund Foreign Large Blend 27.40%
Vanguard Institutional Index I VINIX US Fund Large Blend 21.79%
Vanguard Total Bond Market Index Inv VBMFX US Fund Intermediate-Term Bond 3.46%
American Funds Growth Fund of Amer A AGTHX US Fund Large Growth 26.14%
American Funds Europacific Growth A AEPGX US Fund Foreign Large Growth 30.73%
Vanguard Total Bond Market II Idx Inv VTBIX US Fund Intermediate-Term Bond 3.51%
JPMorgan US Government MMkt Capital OGVXX US Fund Money Market – Taxable 0.77%
Fidelity® 500 Index Investor FUSEX US Fund Large Blend 21.72%

Dividends, gains reinvested through Dec. 29. Data via Morningstar.

The portfolio’s total return: 17.8%, which lags the Standard and Poor’s 500 stock index by a bit more than four percentage points. On the other hand, the portfolio is only 70% invested in stocks, which is what you’d want in a diversified portfolio. The 20% allocation to bonds and 10% allocation to money market securities (as well as a 10% slug of foreign stocks) are reasonable diversification for a moderate portfolio.

Of note, too: This is a dirt-cheap portfolio, with an average expense ratio of 0.25%. Low expenses are one of the single most important predictors of future returns: The less you give to your fund company, the more you get to keep for yourself.

What could go wrong? Three things, none of which seem terribly serious. The first is the preponderance of index funds, which will guarantee you nothing more (or less) than what the market does. If the S&P 500 goes down 20%, this portfolio’s two S&P 500 index funds will go down 20%, too. But it’s unlikely that actively managed funds will get out of the way in time, either: Most didn’t during the 2007-2009 bear market. And remember, the portfolio is only 70% in stocks.

The second is that, thanks to the market’s runup, you’re now about 74% in stocks. This is not particularly something to worry about at the moment. Now, if you had been in these 10 funds for the past 10 years, your portfolio would be 81% in stocks.  This is better than watching your stock allocation shrink. But you might have a greater exposure to stocks in the next bear market than you’d like. If that’s the case, you should sell enough of your winning funds and reinvest the proceeds in your laggards, bringing you back to your original 70% stock allocation.

The final problem is that the 10 funds in the chart are there because they have been wildly successful in the past decade. Money follows success.  It’s a good bet that the 10 largest funds today won’t be the 10 largest in the next decade. When you’re at the top, there’s nowhere to go but down.

Unfortunately, if you’re simply investing in what the company offers, there’s not much you can do about that. Nor, for that matter, can you predict accurately what the 10 largest funds of 2028 will be. The main thing is to keep an amount in stocks that you can live with.

 

 

 

 

 

 

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