Off balance?

Three years ago on this blog, I introduced the Amish Portfolio — essentially a bare-bones, low-cost portfolio for those who get a little buggy by complex investment recommendations. If you have a wood-burning computer to track it, all the better.

The portfolio consists of three funds:

* Vanguard Total World Stock Index fund (ticker: VTWSX). The beauty of this fund is that you don’t have to fret about how much to have in international stocks and how much to keep at home. It’s all in there, according to market capitalization: 56.5% North America, 21.5% Europe, 20.8% Asia, and 8.0% emerging markets. Cost for the investor shares: 0.19% a year, or $1.90 per $1,000 invested.

* Vanguard Total Bond Index fund (VBMFX). You get broad exposure most types of U.S. bonds. Current yield: 2.54%. Cost: 0.15%, or $1.50 per $1,000.

* Vanguard Prime Money Market (VMMXX). Hey, it’s a money fund. It yields 2.03% after its 0.16% expenses.

The suggestion for conservative investors: 20% Vanguard Total Bond, 20% Vanguard Prime Money Market and 60% Vanguard Total World stock. You can add to stocks (and reduce cash or bonds) depending on your personal risk profile.

A mix of stocks, bonds and money market funds is remarkably self-balancing: Despite the stock market’s runup, the conservative blend above is at 65% stocks, 18% bonds and 18% money market funds. It probably doesn’t need to be rebalanced now.

Had this been your portfolio for the past five years, however, you’d now be 76% in stocks — far more than your initial target. In this case, you’d want to sell enough from your stock fund and add to your money fund and bond fund to get to your original 60% stocks, 20% bonds, 20% money fund allocation.

Rebalancing too frequently means that you’ll be cutting off your gains too quickly. (In a taxable account, it means you could be triggering taxes, too). Using the 10% rule typically means occasional rebalancing, and often when one market — stocks or bonds — are a bit frothy. If you’ve been in the market for a while, and you have a set allocation to stocks, now might be the time to rebalance.

 

 

The Amish portfolio

One of the biggest arguments I hear for having a professionally managed account runs like this:

“Hey, it’s a big, complex world. You have so many investment choices: Emerging markets bond funds! Long/short funds! Bank loan funds!You need me to tell you what to invest in, because only I can figure out the right proportion of all these funds for you.”

What’s not usually mentioned, of course, is that much of this complexity is an invention of the financial services industry. No one ever went broke because they didn’t have 2.3% of their portfolio in a long/short fund. Did you miss the runup in REITs last year? Most managers did, too.

An Amish buggy in Lancaster, Pa.
An Amish buggy in Lancaster, Pa.

There are plenty of good reasons to hire professional financial help, but this big old complex world really isn’t one of them. In fact, there’s virtue in Amish-like simplicity. You can construct a low-cost, extremely diversified portfolio with three funds.

We’ll use Vanguard funds because they’re cheap. You could probably construct a similar portfolio with offerings from other companies, although you might not be able to match on cost. The portfolio:

* Vanguard Total World Stock Index fund (ticker: VTWSX). The beauty of this fund is that you don’t have to fret about how much to have in international stocks and how much to keep at home. It’s all in there, according to market capitalization: 54.1% North America, 22.1% Europe, 14.2% Pacific, and 9.4% emerging markets. Cost for the investor shares: 0.27% a year, or $2.70 per $1,000 invested.

* Vanguard Total Bond Index fund (VBMFX). You get broad exposure most types of U.S. bonds. Current yield: 1.9%. Cost: 0.20%, or $2.00 per $1,000.

* Vanguard Prime Money Market. Hey, it’s a money fund. It yields 0.02% after its 0.2% expenses.

That’s it. A conservative mix would be 60% Total World Stock, 20% Prime Money Market and 20% Total Bond Index. You can adjust your stock portion up or down, depending on your risk tolerance. Rebalance whenever the stock portion is 10 percentage points higher or lower than your target.

If you want to add other funds to this basic portfolio, go right ahead. But as any Amish person would tell you, the more you tinker with it, more likely it is to be a little buggy.