What Was Good About Boom-Era 'Lazy' Portfolios

Lazy investors may be less enchanted these days with the Lazy Portfolio approach (investors hold a diversified collection of exchange-traded funds and are spared the task of researching individual stocks). Paul Farrell’s scorecard shows that eight high-profile Lazy Portfolios in the U.S. are down more than 25%, on average, over the year. Over the past five years, annual returns are barely above breakeven.

Drilling down on asset allocations, we see they all had high exposures for stocks. The designers, as has been popular this decade, appear to have been influenced by the empirical studies showing stocks historically have averaged about 9% annually over the long run, better than bonds (5%) and cash (3%).

However, during the recent bull market, dividend yields got down to the 1.5% to 2% range. That was not a good omen because about half of the long-run return on stocks derives from dividend yields of 4.5% earned during the historical periods.

Lazy Portfolios constructed during the bull market were thus destined to earn about 6% annually on their stock exposure (ceteris paribus). The recent crash digs a deep hole for them but the impact may be just to lower long-run equity returns by a third or so (assuming dividends hold up reasonably well during the recession).

In retrospect, by taking valuation levels into account, the boom-era Lazy Portfolios may have captured a better risk-reward ratio by allocating less to stocks and more to investment-grade bonds.

Sensitivity to market valuations is what William Bernstein urged in Chapter Two of The Four Pillars of Investing when he recommended the dividend discount model (DDM) as an alternative to extrapolating expected returns from the past (more on this in my next post). Another approach, which also takes valuations into account, adjusts allocations to stocks according to departures from their historical average return (see the One-Minute Portfolio).

Comments

[fatpitch2]

Larry:
Yes, being "lazy" has not been good... of course being "anything" but in cash or gold for the calendar year 2008 has not been so hot ... as of about a week ago I read that gold was the only asset showing net positive return YTD.

No matter, in general being lazy (in the correct way) removes emotion and frees up time for important stuff like ... oh ... like having a life.

Based on your research can you recommend any semi-lazy portfolios?

I'm trying help build one for a young friend just leaving college with a small inherited nest egg, and as a younger boomer am trying to make my own portfolio lazier as well ;-)

2008 Dec 22 09:46 AM

[bigmoney]

I like the idea of a lazy portfolio, being a layman. I think most people own (or did own) mostly stocks, with a modest amount of bonds and real-estate. If they also had also diversified into commodity / gold and cash, that would have taken the sting out of the market sag. Back then, cash was trash, esp. considering stocks earn 9% over the long run, or very very long run. Cash commodities and gold underperformed for years and decades, so I can see the temptation to avoid those sectors.

2008 Dec 22 05:22 PM

[bigmoney]

I am still undecided on market-cap weighted funds and ETFs. Buy SPY for example, exposes you to bubbles and corrections in particular sectors that got overhyped, such as tech or finance. Furthermore, XLE has about 22% Exxon. It seems like it would be easy for an educated mutual fund manager to outperform this crude approach, but they say that is not very common, and probably not worth the fees they charge.

2008 Dec 22 05:26 PM

[Old Trader]

Larry,

Interesting, and your views mirror my experience. A couple of years ago, after reading one of Farrel's pieces, I constructed a model lazy portfolio after one of the ones he mentioned in the piece. I spend 25-30 hours a week reading, studying, and monitoring my "real" portfolio (I'm not a "pro"), and wouldn't mind losing a couple of points of annual return for a LOT less effort. Suffice it to say. the "model" is down 30%; the "real" portfolio is down 12%. I guess all of those hours DO pay off...

2008 Dec 22 11:03 PM

[fatpitch2]

Here is the review of Farrell's lazy options:

www.marketwatch.com/la...

3 year returns are all negative, 5 year returns are at best about neutral.

2009 Jan 21 08:49 AM

[chippo]

I have to agree, the amount of time I have put into my portfolio over the last decade has taken away from my quality of life. And with the 2008 market, it was time wasted. In fact, I would be probably at the same level if I would just kept all my money in a savings account, and had fun instead of following the market.

I am going to try to rationalize my portfolio, into a few dividend etfs Also try to time the market a little bit by watching the moving averages, so hopefully I can avoid another collapse while trying to regain some of my loses.

2009 Jan 23 07:17 AM

[Al-USA]

Yes, the crossover of the 50sMA over the 200sMA would have taken you out of the market early and avoided the subsequent collapse. It is a very reliable indicator. In terms of laziness, it does not take much to put it into practice.

2009 Feb 08 02:57 AM