A Too-Simple Portfolio

Includes: AGG, EFV, VTI
by: Where is the Yield?

MarketWatch has published this story, repeating the almost-too-fashionable argument about the superfluity of ETFs and how confused investors get bamboozled into paying high fees instead of putting their money in Vanguard's hands, which is presumably what you're supposed to do.

There's nothing new about this, and I wouldn't bring it up if it weren't for an original recommendation made in the article, by Bill Schultheis of Pacific Asset Management. According to him, an investor only needs 3 funds in her portfolio: Vanguard Total Market (NYSEARCA:VTI), iShares MSCI EAFE Value Index (NYSEARCA:EFV) and iShares Lehman Aggregate Bond (NYSEARCA:AGG). Put one third of your money in each - says Schultheis - and "get on with your life."

While the basic idea of passive low-cost investing appeals to me, I can't accept this portfolio. Simplicity is good, but there is such a thing as an oversimplified portfolio. This one is flawed in many ways.

First, I object to any portfolio built for a generic theoretical investor. People are different and they have different needs. For a 65 year-old, for example, the equal-weight three fund allocation suggested by Schultheis is inappropriate, because 66.7% equities is too much.

Secondly, the portfolio has no REITs, which is bad not just because it misses out on alpha, but also because it forfeits the diversification benefit they offer.

A third flaw lies in the large-value bias of the portfolio, both within and without the USA. Smallcap upside is ignored. A bunch of other things are ignored too, from broad themes like energy and water to ideas like fundamental indexing and (god forbid!) dividends.

I could go on faulting the getting-on-with-your-life approach for a while, but the idea is clear. Albert Einstein once said: "Things should be made as simple as possible, but no simpler." Schultheis is wrong to try to make things simpler than possible.