I’m going to try to make a defense of the portfolio. I understand that costs are certain and potential benefits are only possibilities, so I have a high hurdle to jump. I have a portfolio that is basically the exact portfolio that Alan describes. First, this is my portfolio: 40% equity / 25% alternatives / 35% bonds.
40% Equity equally split US/Int heavily tilted to SV
DFA Tax Advantaged US Core 2 (market tilted to SV) 4.0%
DFA Market Wide Value 2 (US Large Value) 2.5%
DFA Tax Managed Targeted Value and Bridgeway Tax Managed Small Value 13.5%
DFA Tax Managed World Ex US (Int market tilted to SV) 2.5%
DFA Int SV, DFA World ex US Targeted Value, DFA Int Vector (Int SV) 12.5%
DFA Emerging Markets Core and DFA Emerging Markets Value 5.0%
Stone Ridge Alternative Lending 4.0%
Clearwater Mid Market Corporate Lending 4.0%
Stone Ridge Reinsurance 4.0%
AQR Style Premia 10.0%
DFA US REIT 2.0%
DFA Int REIT 1.0%
Ladder individual high quality muni bonds with average 5-6 year maturity
About 10% of bond allocation in DFA muni bond fund to have available for rebalancing
The basic beliefs upon which this portfolio is founded include market efficiency, increased compensated risk yields increased expected return, human behavior is tenaciously persistent, modern portfolio theory. I strongly believe in diversifying as broadly as possible across unique and independent sources of risk and return. Most all of our portfolios, even this portfolio, are dominated by the single equity market factor. The goal in creating a more efficient portfolio is to diversify away from this dominant factor to create a portfolio with it’s risks more evenly spread across multiple uncorrelated risks; a move in the direction of risk parity.
A basic tenet of individual investing is that total market or core funds are the cheapest and highly tax efficient. So on the equity side we start with these. These DFA core funds have some tilt toward size and value. They are highly tax efficient. To gain more tilt towards the size and value factors, I add specific small value funds. These are more expensive. But sometimes a more expensive fund can be worthwhile for deeper factor tilts. There are potentially good reasons for an investor to choose a more expensive factor fund. First, deeper exposures mean the investor needs less of the more expensive factor fund to achieve the tilts he is trying to achieve. It is cost per unit factor exposure that matters, not cost alone. Second, with deeper tilts, the investor needs to take on less market beta risk to achieve the tilts he wants, and after all, it is market beta risk he is trying to diversify away from.
Why large value funds and multiple small value equity funds? This answer is easy. First of all, as an investor I’ve evolved over time. I’ve moved toward lower overall equity exposure and increasing tilt to size and value. So, I have some legacy exposure to large value that makes more sense to hold than sell and pay capital gains now. Second, the investing industry evolves too, and new funds can become available over time that might be better. They coud have deeper exposure to desired factors and less cost per unit factor exposure. Third, some funds serve as tax loss harvesting partners for other similar funds.
I expect Alan’s and Bogleheads biggest beef is with the alternatives. Yes they are expensive, but some not as expensive as Alan states. They do provide truly unique, independent, uncorrelated sources of expected return. LENDX, CCLFX, SRRIX are really direct participation in businesses. Some of the alternatives use leverage and the investor’s expense ratio is only on his own investment, yet he potentially benefits from the leverage, so the effective expense ratio on invested money for the investor is less than initially appears.
Anyways, I thought this a reasonable opportunity to make a defense of my highly atypical Boglehead portfolio. As I have written many times, the best and cheapest diversifier of equity risk is high quality bonds. Everything else down the road of what I perceive as increased portfolio efficiency comes at increasing marginal cost and decreasing marginal benefit. That being said, if one thinks a portfolio addition yields net increased marginal benefit, then why not make it? Sometimes people scoff at small 3% allocations, but if it likely makes for a better portfolio, why not make the incremental change? Once again, costs are certain, and improved portfolio efficiency only potential. Each investor needs to decide when potential improvements look large enough to warrant the certain increased costs.
Last edited by Random Walker
on Sat May 15, 2021 8:33 pm, edited 2 times in total.