The Dumbest Portfolio For The Smartest People

Includes: BND, VT
by: Investor1256

Every single day, investors are bombarded by market noise that leads to horrible investment decisions.

The biggest victims of market noise are professional investors. I've walked into many trading desks at hedge funds, and most of the time you see CNBC on the TV. If I was running the desk, the first thing I would do is turn off that junk.

When professors at business schools teach their students about investing, they should reference the expression "can't see the forest for the trees" frequently, because it explains the behavior of most investors. In fact, if you focus on the forest and ignore the trees, in my opinion you will have a portfolio that can build a secure financial future.

Trees like the "fiscal cliff", the Euro meltdown, Greece, etc. are just mere distractions that should be ignored but instead can cause individuals to make decisions that result in great long-term harm to their portfolios. I've seen people cash out all their assets from the market when they have a twenty year time horizon, tilt their portfolios towards foolish (in my opinion) allocations to gold and commodities, invest in "guaranteed" products that deliver low returns with high fees, or just stay frozen in cash for years as inflation eats away at their assets.

Even worse, people who have unrealistic expectations of risk and reward fall prey to the legions of financial con artists (Madoff, etc.) who have been and always will be out there.

Another bad decision is to look to tactical funds or managed accounts that essentially promise to have you in the market when things are going well and out when things are going bad, or shift you in and out of sectors to capture the best sector performance. This frenetic activity only increases trading costs and taxes, and generally lags the market return. Don't do it.

So how do you get into the forest and avoid the trees? Your first step is to invest 100% of your equity allocation into the Vanguard Total World Stock Market Index ETF (NYSEARCA:VT). I suggest this ETF because I believe that it is very important to be diversified globally, and VT is invested across the globe in over 40 countries in proportion to their market capitalization. I don't know of another ETF that has such broad, global market exposure at a cost of .22%. You can also avoid the cost of rebalancing multiple equity holdings by having just one ETF, and automatically avoid being over-concentrated in one country.

You could conceivably own 10-20 individual ETFs that in total might come close to replicating the holdings and broad diversification of VT. There is just no reason to do this, and that is another reason why I find VT to be unique and worthy of 100% of your equity exposure. Just because you only own one ETF does not mean that you are not diversified. With VT I would argue you have the greatest possible diversification available to individual or institutional investors.

Your next step is to apply the same broad, global philosophy to your bond holdings. The investment community often talks at length about global equity diversification, but surprisingly little about global bond diversification, even as global bonds represent the largest component of global capital markets (33% of global capital markets in 2012, according to Vanguard). Unfortunately I have not found one ETF that owns a representation of all global bonds at a low cost, so you must own two ETFs.

The first is the Vanguard Total Bond Market Index ETF (NYSEARCA:BND). This ETF will give you total and complete exposure to the US bond market at a cost of .10%. The other ETF is the Vanguard Total International Bond Market Index ETF (Ticker unknown: launching Q2 2013, see here), with a projected cost of .20%. This ETF applies the same philosophy to international bonds. You can invest 50% of your bond allocation to each ETF.

That is your dumb portfolio. I realize that it seems too simple to be effective, but the elegance is in the simplicity. Overlay a stock/bond allocation that lines up with your age and risk tolerance, and rebalance yearly. Spend the rest of your time actively ignoring the financial news and don't change course when things are going very well or very badly.

This portfolio delivers stunning global diversification at a very low cost. This is the first time in the history of the financial markets you can be so globally diversified. Take advantage of this gift. Get into the forest and stop running into the trees.

Disclosure: I am long BND, VT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.