Lumi’s Lazy Portfolio

Note: Please read the disclaimer. The author is not providing professional investing advice or recommendations.

You may have read that I’ve recently dumped my investing strategy of selecting individual stocks in favor of a broad asset-allocation-through-index-funds approach. In a nutshell, my ongoing formal training as a stock analyst (via the CFA program) opened my eyes as to how little I could actually trust the fundamental ratios (P/E, P/B, D/E, etc.) my previous stock selection strategy was based upon, regardless of how well it seemed to be working.

So until I feel sufficiently skilled in the art of financial statement reverse engineering – necessary to properly analyze a company’s fundamentals – I’m gradually steering my personal assets into a so-called Lazy Portfolio. There are only so many times you can hear about index funds outperforming 75% (or 80% or 85%) of all actively managed funds… or that asset class alone is responsible for 80% (or 90% or 100%) of a portfolio’s returns, before concluding that indexing isn’t just for people who can’t be bothered to do the due diligence of real stock picking. Indexing is due diligence unless or until you have a statistically significant track record in individual stock selection that proves otherwise.


5% Sugar TIPS (Alternative Commodity)

It may sound fairly easy to figure out which asset classes you want to own, what % of your entire portfolio each will represent, and which index funds you’ll buy to obtain said asset classes. After all, you have so many excellent resources to play around with:

WARNING! If you like to tinker, optimize, & simulate these sites can turn into Black Holes to All Free Time.

    • The Lazy Portfolio Center at marketwatch.com provides continually updated performance for 8 intriguing Lazies you can either copy or use as a starting point to roll your own.
    • Assetplay.net is a free site with a backtesting tool that lets you simulate hypothetical Lazy Portfolios with annual rebalancing going all the way back to 1972! Plus you can examine rolling returns as well. There are a staggering 23 asset classes to choose from and they also have some sample portfolios to get you started.
    • For the real junkies, who want to be able to examine returns of more narrow asset classes (like individual countries, instead of just broad regions), the MSCI-Barra site has an extensive free database with downloadable annual returns. Be sure to read this part of their FAQ to make certain you select the proper data format. Of the 3 types they offer, I personally prefer the “Gross” option as returns are computed as if you reinvested all dividends.

After exploring these three in depth, the R&D side of my brain just couldn’t stand not downloading the asset class returns and writing a script to do a little historical backtesting of my own through mean-variance optimization. I’ve basically had one of my old laptops cranking away night and day for weeks just to see what efficient portfolios pop out for various time periods.

But here’s one of the most important pillars to constructing one’s Lazy Portfolio. It is very important that you like and believe in your asset allocation. If you don’t, you greatly risk abandoning it whenever times get irrationally exuberant or pessimistic. And if history is any judge, this would most likely result in your buying high and/or selling low.

This “belief factor” is the reason that, in the end, I decided to deep six all the efficient portfolios from my laptop’s data-mining expedition. I could imagine the “past returns may be no indication of future results” thought coming for repeated visits at 2 AM whenever the chips are greatly down (or up), coercing me to abandon my allocation strategy.

So in the end, here is what I decided upon. Some of my decisions are based upon historical performance, but only broadly. You should also know that at age 36 I have a fairly long time horizon and experience no digestive upsets with wild swings in the market value of my assets (as long as I believe in what I’ve bought).

10% US Large Cap Value
Most cookie cutter allocations for US investors include a large percentage devoted to US stocks, particularly large caps as they’re supposed to be more stable and recession-resistant due to their diversification of products, global buyers, access to credit, economic moats, cash on hand, etc. I don’t like putting too much money into any single country, my own included, regardless of the fact that it produces 25% of the world’s GDP. So I park 10% in large caps but choose value rather than growth or blend to hopefully capture the value premium.
1972-2007 Annualized Return=13.07%, Suggested Ticker:VIVAX

10% US Small Cap Value
Another 10% into US equities, this time the small caps due to their historically superior returns. Again I choose value in an attempt to capture that extra risk premium. The smaller size should theoretically yield a second risk premium on top of that fi you believe Fama and French.
1972-2007 Annualized Return=14.3%, Suggested Ticker:NAESX

5% US Mid Cap Value
This is sort of an oddball in my Lazy, because it’s mostly a placeholder for the future. You see, at some point I do see myself going back to picking individual stocks once I feel I know what I’m doing. But all will still be selected to fit into this same overall asset allocation. The reality will be that as the market fluctuates some large caps and small caps will become mid caps. I don’t want this to be a reason to immediately sell when re-balancing so I’m allocating a 5% buffer zone in between the large and small caps specifically for this purpose.
1972-2007 Annualized Return=13.5%, Suggested Ticker:IJJ
(note this is for mid-cap blend as value data is not available going back to 1972)

20% European Developed Markets
After US stocks, a logical addition are the developed markets of Europe, Asia, and the Far East (EAFE). You can certainly buy EAFE all in one fund but doing this exposes you unnecessarily to a weakness of all market-cap weighted indexes. If a bubble causes one particular part of the index’s stocks to take over more and more of the index’s market cap, you’re buying and owning more and more of said bubble. So I steal from All About Asset Allocation, breaking EAFE into it’s two components – Europe and the Pacific Rim, and investing in them separately. I allocate more to Europe due to it’s higher historical annualized return and the fact that more countries comprise the index.
1972-2007 Annualized Return=12.5%, Suggested Ticker:VEURX

10% Pacific Rim
The other part of EAFE – mostly consisting of Japan and Australia.
1972-2007 Annualized Return=10.9%, Suggested Ticker:VPACX

15% Emerging Markets
By conventional standards, this seems like a large amount devoted to such a risky asset class. But if you’ve done any historical backtesting over long periods, you’ve no doubt noticed that emerging markets have produced the highest average return (along with extreme volatility). Why is there no talk of the “emerging” premium alongside the “value” and “size” premiums? A strong part of me wants to park 100% of my money here until I begin to approach retirement. I don’t do it because I don’t know anyone else who does. Either I’m kowtowing to the wisdom of the experts and crowds or I’m just plain kowtowing and need to grow a backbone.
1972-2007 Annualized Return=19.3%, Suggested Ticker:VEIEX

15% REITs
In Unconventional Success, REITs are described as a sort of “in-between” asset class. That is, historical returns have been higher than bonds, but lower than stocks. I don’t personally like to invest a lot in bonds knowing that stocks have outperformed, but 15% in REITs kills two birds with one stone. Birdie #1 is that I’m seeking diversification. Birdie #2 is that I informally count this as 7.5% invested in bonds which makes me feel better when added to actual amount allocated to bonds below.
1972-2007 Annualized Return=12.9%, Suggested Ticker:VGSIX

10% Total Bond Market
So you’re supposed to put some money in bonds for safety. Benjamin Graham recommended at least 25%. Other experts have your bond holding % being the same as your age. One great thing about bonds is the fixed income that appears in your account when the market takes a dive. You’re dying to go on a buying orgy when the market has dropped 25% but if you’re fully invested you have little cash with which to do so. Bond allocations provide an IV liquidity drip on a monthly basis for that. They also force you to take some money off the hot equities table whenever re-balancing time comes around.
1972-2007 Annualized Return=8.0%, Suggested Ticker:VBMFX

5% TIPS
David Swensen, Yale’s successful endowment manager, says a particular asset class needs to be at least 5% to make any noticeable difference on your portfolio. Since I’m looking for a small amount of additional inflation hedge, 5% in TIPs is the final piece of the puzzle. So this gives me 10% + 5% + 7.5% = 22.5% in bonds. Not near my age but a good enough show!
1972-2007 Annualized Return=7.8%, Suggested Ticker:TIP

And that’s it. There are a few classes not represented (commodities, micro caps, foreign debt, etc.) but I haven’t found strong evidence of their necessity and am trying to keep things simple. Speaking of which, I still can’t help dreaming of dumping it all into emerging markets. With an average annualized historical return of 19.3% over my lifetime, is there a chance it will continue to double the money of brave investors’ every 4 years?

3 thoughts on “Lumi’s Lazy Portfolio”

  1. well just some insight into emerging markets, I’m from Kuwait (in the arabian gulf), which is considered an emerging market, or even smaller, (www.kse.com.kw)”Kuwait Stock Exchange”.
    If you have invested from 2000 you would at least be making 500% and that is through a fund (http://www.markaz.com/DesktopDefault.aspx?tabindex=2&tab_ikey=103)
    , but of course the market dipped around 40% in 2008 due to the financial crisis and oil being around $40.
    but the market has a P/E of around 8. and many of the stock having P/E’s as low as 0.7!

    so I think diversifying through emerging markets is really a good IDEA.
    I’m actually looking into investing into CHINA, which has been in the lows for a long time now, and it being not that much affected by the crisis.

  2. thanks for the link, momo

    wow, a 28% compound annual growth rate since 2000, including 2008. any idea what inflation has been during this time period?

    yes emerging and frontier markets are definitely where the excitement is at in my book. i hope to gain more experience in this area instead of having to settle for just buying indexes.

    – lumi

  3. well, I don’t remember what was the inflation rate a couple of years ago, but this year it was at a high of 12%.
    the problem with emerging markets is that there’s no transparency in information and no data, such as whats available in the U.S, so it would be very hard to use all tools (learned by CFA at least) to analyze companies. full 3rd quarter financial statement are still not easy to get!
    so this is why some mutual funds come in handy.

    links to other mutual funds:
    http://www.eahli.com/abk/investments_kuwaiti_fact.html
    http://www.nic.com.kw

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