Four-fund max?

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Greenman72
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Four-fund max?

Post by Greenman72 »

First-time poster here. I have a question for the "smart" people on the board--that is, those who have software and enjoy research. I was directed here by somebody on another forum, specifically to the "DFA--Where's the alpha?" thread. (Thanks to him who referred me, if you're reading this.)

A little about me--I used to be a financial advisor, but lost interest in it for many reasons that Bogleheads would respect. I went back to school, and am now a rookie CPA working in a tax practice. I have also passed all three levels of the CFA exam. I believe that there's a real possibility of a synergistic relationship when your tax accountant is also your investment advisor.

One thing to note--I'm not a "true" Boglehead. That is, I do believe that some advisors are worth their salt. (Unfortunately, they are few and far between, and hard to identify.) I believe that there are many people out there who are simply unwilling or unable to learn how to run their own investments, and are perfectly willing to pay an advisor to do it. And for that reason, I hope someday to introduce investment management as part of the package that we offer our customers. (Feel free to critique this, if you want. But that's not really what I'm getting at....)

On another forum, I suggested that I could create a portfolio for our customers using a "four-fund-max" rule. That is, for most customers (unless they are extremely wealthy or sophisticated), you should be able to create a portfolio that captures substantially all of the return (obviously with the desired amount of risk) using a maximum of four funds.

(Note that they don't have to be the same four funds for everybody. That is, one client might need a muni bond fund, a LT-govt bond fund, a medium-term corporate bond fund, and a total-stock market fund. Another client might want total US-stock market, total international stock market, emerging market, and REITs. They're different funds, but still a maximum of four.)

When I posited this on the other forum, my theory was quickly discounted (by people who admittedly were wholesalers or institutional portfolio managers) saying that it was too simple, and this didn't expose the clients to nearly enough asset classes. They claimed that to really do a service to clients, you needed 10-15 different funds. But I wonder--how much risk/return would we actually capture by investing in emerging market high-yield floating-rate corporate bonds? Do we really need to add an additional fund for that?

Does anybody know of any info or data that repudiates or validates my claim that you need only four funds to achieve investing goals? Would having a 15-fund portfolio generate any additional return per unit of risk?

Any help would be appreciated. Thank you.
chaz
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Re: Four-fund max?

Post by chaz »

There is a good thread on this forum "the 3 fund portfolio".

Keep it simple.

Look at the forum wiki.
Chaz | | “Money is better than poverty, if only for financial reasons." Woody Allen | | http://www.bogleheads.org/wiki/index.php/Main_Page
madmanx
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Re: Four-fund max?

Post by madmanx »

There was a similiar thread to this in June based on an article by Rick Ferri. More about holding more active funds (which I'm sure the investors you talked to are adocating). Basically the conclusion is the more active funds you hold the greater the chance of an index fund outperforming.

http://www.bogleheads.org/forum/viewtop ... &p=1733249

BTW, I do not think boggleheads uniformly dismiss using an advisor. If the advisor helps their clients stay the course and keeps fees low they can be provide value in volitile markets.
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Watty
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Re: Four-fund max?

Post by Watty »

That is, I do believe that some advisors are worth their salt.
Lots of fee only advisors are worth their salt, it is the ones that cost an arm and a leg that are the problem.

When advisors do things like helping with asset allocation, tax planning, estate planning, setting up realistic budgets, risk tolerance, or managing funds for an incompetent person there is a of value that they can realistically add that can justify reasonable fees.

Even picking specific investments to overweight or avoid for specific tax or estate planning reasons is reasonable thing that can make a lot of sense for specific individual.

Trying to pick a group of superior mutual funds is not anything new so you might want to research the history of "fund of funds" that were starting maybe 25 or more years ago. Some of these ended up being superseded by things like target date funds, but most of them didn't do all that well since trying to pick superior mutual funds is just as hard as trying to pick superior stocks but with an extra layer of fees.
avalpert
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Re: Four-fund max?

Post by avalpert »

You'll have to define what you mean by "captures substantially all of the return" for any data to be meaningful.

If by that you meant the expected return of the market, in this day and age you can do it with two funds. If you mean the maximum return available, well that can only be done with one fund but it has to be the right one. If you mean maximum return for the advisor that number will be directly proportional to the tolerance of the customer.
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magician
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Re: Four-fund max?

Post by magician »

Green: where's your avatar?
Simplify the complicated side; don't complify the simplicated side.
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momar
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Re: Four-fund max?

Post by momar »

Why do you need 4 whole funds? Seems like 2 would be enough, with the advent of total world stock funds.
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nisiprius
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Re: Four-fund max?

Post by nisiprius »

Using argumentum ad Vanguardum, look at the current composition of Vanguard's target-date retirement funds:

Image

For what it may be worth, when it comes to these core all-in-one retirement funds which Vanguard offers for 401(k) plans, they are willing to stake their reputation on four funds being enough.

Compared to other companies using much more complex portfolios, Vanguard has done worse than some (T. Rowe Price) and better than others (Fidelity).
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Jazztonight
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Re: Four-fund max?

Post by Jazztonight »

Let me take the liberty of re-phrasing what I think you may be asking:

I suspect that in your role as a CPA/CFA, you're attempting to provide a service, perhaps an additional service, to your clients and potential clients, and have come up with a concept to do that in a relatively simple manner--a four fund portfolio that meets their specific needs as you see them as their advisor. Perhaps the choosing or recommending of these four funds will be part of your fee package, or an add-on, or a stand alone fee for service. I also understand that "my four funds" are not necessarily going to be my father's four funds (I have him in muni- and tax-free bond funds, etc.).

As a financial professional, you may be in a good position to offer these services, and if you're honest and not greedy, hey, that's great! Lots of people out there (most?) seem not to have a financial clue, so you'd be doing a mitzvah.

That said, Bogleheads typically believe in simplicity and doing-it-themselves. That's why they're showing you the Vanguard funds and Target funds that are already pre-packaged. That might be one of the choices you'd recommend to specific clients with only a few thousand dollars to invest.

When I had a CPA years ago, I wish he'd set me up with a few (4?) Vanguard index funds and charged me a reasonable fee and helped me educate myself. But that did not happen.

Good luck with your firm and your career and your concept.
"What does not destroy me, makes me stronger." Nietzsche
leo383
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Re: Four-fund max?

Post by leo383 »

Total Stock Market
Total International Stock
Total Bond
Small Cap Value if you'd like to tilt a bit.
pkcrafter
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Re: Four-fund max?

Post by pkcrafter »

Welcome to the forum,
Greenman72 wrote:
A little about me--I used to be a financial advisor, but lost interest in it for many reasons that Bogleheads would respect. I went back to school, and am now a rookie CPA working in a tax practice. I have also passed all three levels of the CFA exam. I believe that there's a real possibility of a synergistic relationship when your tax accountant is also your investment advisor.

Yes, that's a good combination.

One thing to note--I'm not a "true" Boglehead. That is, I do believe that some advisors are worth their salt. (Unfortunately, they are few and far between, and hard to identify.) I believe that there are many people out there who are simply unwilling or unable to learn how to run their own investments, and are perfectly willing to pay an advisor to do it.

There are many Bogleheads who use advisors for various reasons, so you can be a Boglehead and believe some people prefer/need an advisor. The fact is whether a person uses an advisor or not, they do have some responsibility to at least understand the fundamentals of investing, and that's why some who do use advisors are Bogleheads. If investors don't understand basics, they can't even evaluate the advice provided by a professional advisor.

On another forum, I suggested that I could create a portfolio for our customers using a "four-fund-max" rule. That is, for most customers (unless they are extremely wealthy or sophisticated), you should be able to create a portfolio that captures substantially all of the return (obviously with the desired amount of risk) using a maximum of four funds.

Yes, it can be done very effectively. Total Stock Market, Total International, REIT, Bond. This is called Rick Ferri's Core Four. It can also be done with three funds by omitting REIT.


(Note that they don't have to be the same four funds for everybody. That is, one client might need a muni bond fund, a LT-govt bond fund, a medium-term corporate bond fund, and a total-stock market fund. Another client might want total US-stock market, total international stock market, emerging market, and REITs. They're different funds, but still a maximum of four.)

You do have to be careful about choosing 4 funds that don't fully cover the markets. Bond fund choices can vary widely and taxable accounts might influence bond fund choices. If a client wants an undiversified portfoio, it would be the advisors job to correct it.

When I posited this on the other forum, my theory was quickly discounted (by people who admittedly were wholesalers or institutional portfolio managers) saying that it was too simple, and this didn't expose the clients to nearly enough asset classes. They claimed that to really do a service to clients, you needed 10-15 different funds. But I wonder--how much risk/return would we actually capture by investing in emerging market high-yield floating-rate corporate bonds? Do we really need to add an additional fund for that?

It's pretty easy to see that most advisors need to show their expertise by recommending something more complex than it needs to be. In fact, there are many unskilled investors who would be thoroughly disappointed if their advisor suggested a portfolio that looked to simple, so there is a strong psychological element involved.

Here are some effective slice and dice portfolios from the Bogleheads Wiki. Note, all are effective, so it comes down to risk and preference.


http://www.bogleheads.org/wiki/3_Fund_Lazy_Portfolios

Does anybody know of any info or data that repudiates or validates my claim that you need only four funds to achieve investing goals? Would having a 15-fund portfolio generate any additional return per unit of risk?

Yes, there is lots of evidence. Here's Taylor Larimore's post on the 3 fund portfolio. It's very doubtful that a 15 fund portfolio would generate additional return, and you would have a mess if they were actively managed funds.


http://www.bogleheads.org/forum/viewtop ... 10&t=88005


Paul
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dbr
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Re: Four-fund max?

Post by dbr »

avalpert wrote:You'll have to define what you mean by "captures substantially all of the return" for any data to be meaningful.

If by that you meant the expected return of the market, in this day and age you can do it with two funds. If you mean the maximum return available, well that can only be done with one fund but it has to be the right one. If you mean maximum return for the advisor that number will be directly proportional to the tolerance of the customer.
Yep, "capture all the return" is a financial advisorly type concept that needs explication before the question can be answered.
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ruralavalon
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Re: Four-fund max?

Post by ruralavalon »

Welcome to the forum :) .
Greenman72 wrote:One thing to note--I'm not a "true" Boglehead. That is, I do believe that some advisors are worth their salt. (Unfortunately, they are few and far between, and hard to identify.) I believe that there are many people out there who are simply unwilling or unable to learn how to run their own investments, and are perfectly willing to pay an advisor to do it. . . . .
Not so, many here including myself recognise the value of a reasonably priced fee-only advisor. I had that help getting started on index fund investing.

The primary objection to is to persons claiming to be "advisors", but who are instead salesmen selling stocks, bonds, insurance products, or high expense load funds on commission rather than selling disinterested well-informed advice.

There is nothing wrong with working on commission or being in sales. Its representing that they are something other than a salesman.
Greenman72 wrote:On another forum, I suggested that I could create a portfolio for our customers using a "four-fund-max" rule. That is, for most customers (unless they are extremely wealthy or sophisticated), you should be able to create a portfolio that captures substantially all of the return (obviously with the desired amount of risk) using a maximum of four funds.
Probably true in many instances, see: Wiki article link: Lazy portfolios .
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
stan1
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Re: Four-fund max?

Post by stan1 »

From a business model perspective you probably want to look at what Personal Capital is doing. They are targeting younger investors (comfortable with internet) with $500K-$2M in assets using a mostly Boglehead approach. One main difference is that they advocate sector weighting using baskets of individual stocks for US rather than something like Total Stock Market. They use more than 4 funds/ETFs also. Appears to have a fairly automated platform and they are backed by some big names -- including Bill Harris (former CEO of PayPal). Their fee structure (starting at 0.95%) would be a hard sell to a Boglehead but I think gives you an idea of what you'd be up against from a competitive perspective.
umfundi
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Re: Four-fund max?

Post by umfundi »

stan1 wrote:From a business model perspective you probably want to look at what Personal Capital is doing. They are targeting younger investors (comfortable with internet) with $500K-$2M in assets using a mostly Boglehead approach. One main difference is that they advocate sector weighting using baskets of individual stocks for US rather than something like Total Stock Market. They use more than 4 funds/ETFs also. Appears to have a fairly automated platform and they are backed by some big names -- including Bill Harris (former CEO of PayPal). Their fee structure (starting at 0.95%) would be a hard sell to a Boglehead but I think gives you an idea of what you'd be up against from a competitive perspective.
Along these lines, WealthFront can claim they have Burton Malkiel: https://www.wealthfront.com/

This is not a recommendation of what WealthFront does.

Keith
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stan1
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Re: Four-fund max?

Post by stan1 »

Yes, anyone looking at the business of being a financial advisor needs to understand what both Wealthfront and Personal Capital are doing. Personal Capital has advisors along with their computers. Wealthfront just has computers so they can get their fee down to 0.25% AUM.

(And I also am not advocating either product, just looking at their business models which seem to be poised to scale up in terms of the number of clients).
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Greenman72
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Re: Four-fund max?

Post by Greenman72 »

Thanks for the responses, guys.

One thing that somebody on the other forum pointed out--if you are a financial professional and hold only four funds, then it might be viewed as too simple, and might be a lawsuit waiting to happen. That might be a deterrent for a financial advisor (even a "good" one). Plus, I don't know if regulators would be keen on an advisor charging a fee to buy-and-hold a couple of index funds. Whether this is good or bad for the client, it might make things difficult for the advisor, knowing that he's opening himself up to potential lawsuits and censures from FINRA. Anybody have any knowledge about how this works in practice?
avalpert
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Re: Four-fund max?

Post by avalpert »

Greenman72 wrote:Thanks for the responses, guys.

One thing that somebody on the other forum pointed out--if you are a financial professional and hold only four funds, then it might be viewed as too simple, and might be a lawsuit waiting to happen. That might be a deterrent for a financial advisor (even a "good" one). Plus, I don't know if regulators would be keen on an advisor charging a fee to buy-and-hold a couple of index funds. Whether this is good or bad for the client, it might make things difficult for the advisor, knowing that he's opening himself up to potential lawsuits and censures from FINRA. Anybody have any knowledge about how this works in practice?
I've never heard of a financial advisor being sued for having 'too simple' an investment portfolio - that just sounds like BS excuse for generating more fees through active trading.
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