The Quest for Perfection

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TD2626
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The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 2:59 pm

I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be. Please poke holes in one iteration of my thinking.

Disclaimer - note that this is completely hypothetical, is not a suggestion, and may not even be a good idea. It simply represents the results of my thinking on what a complete portfolio could look like. This is what happens when I overthink things…. Anyway, here goes:

Stocks (85% total):
30% Vanguard Total World Stock Index Fund
10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
5% Vanguard Small Cap Value Index Fund
5% Vanguard Emerging Markets Stock Index Fund
15% Passive Individual Stock Portfolio: About 30 Mega-Cap, Large-Value Individual Stocks. Buy & Hold Forever. Each should be about 0.5% of portfolio. Mostly Dow Stocks.
3% Vanguard Wellington Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
3% Vanguard STAR Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
2% Dodge and Cox Stock Fund
2% Vanguard Strategic Equity Fund (VSEQX)
2% Vanguard Equity Income Fund Investor Shares (VEIPX)

Bonds (10% total):
2.5% Vanguard Total Bond Index Fund
0.75% Vanguard Total International Bond Index Fund
1% National Long-Term Muni Bond Fund, with lower credit quality
1% State-Specific Long-Term Muni Bond Fund
0.75% Vanguard Long Term Vanguard Long-Term Government Bond Index Fund Admiral Shares (VLGSX)
0.75% Vanguard Long-Term Corporate Bond Index Fund Admiral Shares (VLTCX)
0.25% Vanguard EM Gov’t Bond Fund
0.25% Vanguard High-Yield Corporate Fund Investor Shares (VWEHX)
0.5% CD at a local bank with >6 month maturity
0.25% Paper iBonds
(2% Bond Exposure from Active Funds Listed in Stocks)

Cash and Alternatives (5% total):
2% HY Savings Accounts (3, at different banks, some online, but several brick and mortar)
1% Checking Accounts (2, at different banks, at least two brick and mortar)
1% Money Market Funds (2)
0.9% CD at a local bank with <6 month maturity
0.05% Precious Metals (several kinds)
0.05% Currency

Benefits:
Easy to manage with reasonable number of holdings (<60)
Exposure to a variety of factors, including small and value
Complexity and high diversification could reduce fat tail risk
High total return over the long run with reasonable, but high, risk.
Income-producing securities could provide income in times that it is needed while not reducing total return due to the Modigliani-Miller Theorem
Exposure to undiscovered factors through actively managed holdings
Very, very low expense ratio of overall portfolio

bloom2708
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Re: The Quest for Perfection

Post by bloom2708 » Tue Jul 18, 2017 3:01 pm

TD2626 wrote: Easy to manage with reasonable number of holdings (<60)
:shock:

Can you envision keeping your .25% funds at their desired allocation? Yikes.

Less is more. More is much much more.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

Thesaints
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Re: The Quest for Perfection

Post by Thesaints » Tue Jul 18, 2017 3:05 pm

60 holdings ? On how much capital ? You can easily build an optimal multi-million portfolio with 6

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willthrill81
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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 3:08 pm

Way too many parts.

IMHO, no part of a portfolio should be less than 5%. Otherwise, it's just too small to move the needle.

Why would you want a global stock fund, plus US, plus international? The former seems entirely superfluous.

With only 10% in bonds, keep it simple with either TBM, ITT, or some combination of STT and LTT.

The last 5% in cash and alternatives isn't likely to help you much, if at all.

Why not start with a 3 fund portfolio, then add in small cap value and emerging markets if you want that added exposure?
Last edited by willthrill81 on Tue Jul 18, 2017 3:12 pm, edited 1 time in total.
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Taylor Larimore
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Complexity vs. Simplicity

Post by Taylor Larimore » Tue Jul 18, 2017 3:11 pm

I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be. Please poke holes in one iteration of my thinking.
TD2626:

If you are serious, please read my "Simplicity" link below.

Thank you and best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

KlangFool
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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 3:13 pm

OP,

1) It is pointless to hold anything with less than 5% of your portfolio.

2) If you cannot come up with a compelling answer why something will make a significant difference to your portfolio, you should not add them in.

3) Start with the 3 funds. Then, see how far you can add fund before you stop. I can only add maybe 2 funds if I do the exercise. I will have 5 funds.

4) I cannot imagine how you can justify your proposed portfolio.

KlangFool

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TD2626
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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 3:22 pm

I feel as though this is a fairly simple and elegant portfolio. I recognize the need for simplicity, but believe that excess simplicity can be dangerous.

Furthermore, I carefully considered each allocation and feel each can be justified.

For example, this is designed for two purposes:
TD2626 wrote: 30% Vanguard Total World Stock Index Fund
10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
1. To reduce fat tail risk. For example, having one brokerage account be hacked when the other isn't could occur. Diversifying among fund providers is important.
2. To have a portfolio that is overwhelmingly based on globally cap weighted equities at low expense ratios.

Many other small allocations are needed because they are excluded from Total Bond. Total Bond doesn't have muni bonds or high yeild, so these funds had to be added in to the portfolio at a small allocation.

I simplified the portfolio where possible - for example, REITs are excluded because they are represented in the Total Stock index fund.

Thesaints
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Re: The Quest for Perfection

Post by Thesaints » Tue Jul 18, 2017 3:27 pm

I'd love to see something you consider "complicated", then.

Usually, account hacking is not considered amongst the relavant risks since brokerage houses are insured.
Unless, of course, you have a very large account exceeding insurance linits and then one may want to take special countermeasures.

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willthrill81
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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 3:29 pm

TD2626 wrote:I feel as though this is a fairly simple and elegant portfolio. I recognize the need for simplicity, but believe that excess simplicity can be dangerous.

Furthermore, I carefully considered each allocation and feel each can be justified.

For example, this is designed for two purposes:
TD2626 wrote: 30% Vanguard Total World Stock Index Fund
10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
1. To reduce fat tail risk. For example, having one brokerage account be hacked when the other isn't could occur. Diversifying among fund providers is important.
2. To have a portfolio that is overwhelmingly based on globally cap weighted equities at low expense ratios.

Many other small allocations are needed because they are excluded from Total Bond. Total Bond doesn't have muni bonds or high yeild, so these funds had to be added in to the portfolio at a small allocation.

I simplified the portfolio where possible - for example, REITs are excluded because they are represented in the Total Stock index fund.
Why is "elegance" important? How is a portfolio with so many funds elegant at all? Keep in mind that Harvard has been recently moving away from this type of portfolio to a much simpler, index driven one.

If you want multiple fund providers, I suppose that's alright (I personally see no need as your account isn't going to get hacked and your assets drained overnight). But you can hold the same asset class with multiple fund providers.

You don't need municipal bonds unless (1) the bonds are in a taxable account and (2) you are in the highest income tax brackets. Similarly, high yield bonds are not necessary, especially at such a small allocation in the total portfolio.

What do you mean by "overwhelmingly based on globally cap weighted equities?" Either a portfolio is globally cap weighted or it isn't. If you just bought a world stock fund, you would always be globally cap weighted. By buying US and international separately, you may lose this weighting over time.

Again, why would you want less than 5% of anything in a portfolio? Such small percentages are just not really capable of affecting your portfolio.
Last edited by willthrill81 on Tue Jul 18, 2017 3:31 pm, edited 1 time in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

BW1985
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Re: The Quest for Perfection

Post by BW1985 » Tue Jul 18, 2017 3:30 pm

That portfolio would give me a headache. I own 3 funds.
"Squirrels figured out how to save eons ago. They buried acorns. Some, they dug up, for food. Others, they let to sprout, in new oak trees. We could learn from squirrels." -john94549

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TD2626
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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 3:32 pm

Having a small allocation to active, as is shown here
TD2626 wrote:3% Vanguard Wellington Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
3% Vanguard STAR Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
2% Dodge and Cox Stock Fund
2% Vanguard Strategic Equity Fund (VSEQX)
2% Vanguard Equity Income Fund Investor Shares (VEIPX)
is based on ideas I discussed here: viewtopic.php?f=10&t=221271#p3415505 - that having 5-10% of the portfolio in low cost active may make an improvement

The ~30 individual stocks are due to the cost and tax loss harvesting advantages discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Individual stocks have no expense ratio and have TLH opportunities.

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willthrill81
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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 3:35 pm

TD2626 wrote:Having a small allocation to active, as is shown here
TD2626 wrote:3% Vanguard Wellington Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
3% Vanguard STAR Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
2% Dodge and Cox Stock Fund
2% Vanguard Strategic Equity Fund (VSEQX)
2% Vanguard Equity Income Fund Investor Shares (VEIPX)
is based on ideas I discussed here: viewtopic.php?f=10&t=221271#p3415505 - that having 5-10% of the portfolio in low cost active may make an improvement

The ~30 individual stocks are due to the cost and tax loss harvesting advantages discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Individual stocks have no expense ratio and have TLH opportunities.
Having 10% (subtracting the 2% of STAR in bonds) of the portfolio in actively managed stocks isn't likely to make a significant difference in your portfolio. If it outperforms the other stocks by 10%, which is unlikely to occur over the long-term, then your portfolio would have benefited by only 1%.

You'd be better off sticking the 5% devoted to cash and alternatives in a stock index fund, unless your holding them for security, in which case STT or ITT would work fine.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Thesaints
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Re: The Quest for Perfection

Post by Thesaints » Tue Jul 18, 2017 3:37 pm

Well, those 30 individual stocks you have to buy them (and eventually sell them). Chances are you will be getting less favourable prices than block traders.

If you want to increase volatility, why don't you just take on a little more stocks ?

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KlingKlang
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Re: The Quest for Perfection

Post by KlingKlang » Tue Jul 18, 2017 3:37 pm

BW1985 wrote:That portfolio would give me a headache. I own 3 funds.
I own more than 3 funds, but ghee. Why do you need to own the top 20 stocks in the S&P 500 in 8 separate funds?

bigred77
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Re: The Quest for Perfection

Post by bigred77 » Tue Jul 18, 2017 3:40 pm

My counter to you is that why is what you proposed "better" than sticking everything in 1 position: Vanguard LifeStrategy Growth.

I know for a fact my strategy would be easier to implement, monitor, require less time tweaking, encounter lower costs, and need far less transactions to maintain.

I'm almost certain my proposal would have better risk adjusted returns. You may be over weighting factors, but you are also taking on manager risk as well as betting 15% of your portfolio on your own ability to pick stocks.

I'd bet my proposal would have better absolute returns (but I you would 85% stocks vs. only 80% for me).

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TD2626
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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 3:40 pm

willthrill81 wrote:You don't need municipal bonds unless (1) the bonds are in a taxable account and (2) you are in the highest income tax brackets. Similarly, high yield bonds are not necessary, especially at such a small allocation in the total portfolio.

What do you mean by "overwhelmingly based on globally cap weighted equities?" Either a portfolio is globally cap weighted or it isn't. If you just bought a world stock fund, you would always be globally cap weighted. By buying US and international separately, you may lose this weighting over time.
Many, if not most, investors are in the 25% bracket. Theory suggests that the 25% tax bracket is the break-even point where the after tax yield between munis and taxable bonds is roughly equal. Thus, it would be acceptable to hold both munis and taxable. The desire for diversification would suggest holding both - diversification is the only free lunch due to Modern Portfolio Theory (low correlation between risks affecting municipalities vs corporations could improve portfolio Sharpe ratio).

Regarding the global cap weighting - much of the portfolio is globally cap weighted. However, there are mild tilts. The 30% total world would drift with the US's share of the global stock market, while the 10% Total US / 10% Total International would be re-balanced routinely to ensure that the portfolio does not get too overwhelmingly US-based or International-based. Overall, there's a few small-ish tilts towards EM and Small-Value, as well... which should in aggregate increase returns somewhat in exchange for somewhat higher risk.

KlangFool
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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 3:41 pm

TD2626 wrote:I feel as though this is a fairly simple and elegant portfolio. I recognize the need for simplicity, but believe that excess simplicity can be dangerous.

Furthermore, I carefully considered each allocation and feel each can be justified.
TD2626,

1) Write one paragraph per holding and explain why and how it makes any difference.

2) Anything less than 5% of your portfolio is immediately ruled out. This limit you to 20 holdings.

If you want a serious discussion, please do (1) and (2).

<< 30% Vanguard Total World Stock Index Fund
10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund>>

<< 1. To reduce fat tail risk. For example, having one brokerage account be hacked when the other isn't could occur. Diversifying among fund providers is important.
2. To have a portfolio that is overwhelmingly based on globally cap weighted equities at low expense ratios.>>

A) If you care about protecting yourself across provider, you can spread your holding across 2 providers. Duplicating asset classes across 2 providers do not make any sense.

B) If either Vanguard or Fidelity is hacked, I seriously doubt that the other is safe too.

C) I work in IT world. You are asking the wrong question. The correct question should be if your account is hacked, can you protect yourself from serious damage? It is just a matter of time that you will be hacked.

KlangFool

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saltycaper
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Re: The Quest for Perfection

Post by saltycaper » Tue Jul 18, 2017 3:42 pm

TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be.
It ain't this. :D
TD2626 wrote: Easy to manage with reasonable number of holdings (<60)

This would not be easy to manage at all, IMO, especially if you have to spread it across multiple accounts.

Exposure to a variety of factors, including small and value

There is very little exposure to small and value. I'd say the exposure is inconsequential.

Complexity and high diversification could reduce fat tail risk.

:confused Complexity doesn't reduce fat tails.

High total return over the long run with reasonable, but high, risk.

I guess that's subjective, but risk is too high for me.

Income-producing securities could provide income in times that it is needed while not reducing total return due to the Modigliani-Miller Theorem.

No. If you spend the income you are reducing return. Don't see what that has to do with MM.

Exposure to undiscovered factors through actively managed holdings

That's a leap. Just because something's actively managed doesn't mean it will necessarily expose you to anything not yet discovered.

Very, very low expense ratio of overall portfolio

Okay. I'll give you that one.
I think this is a terrible, horrible, no good, very bad portfolio. It's just a ghastly construction. Also, it's horrendous. Did I mention how awful I think it is? Finally, I think it's atrocious.

P.S. It's just shockingly horrid.

:D
Quod vitae sectabor iter?

alex_686
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Re: The Quest for Perfection

Post by alex_686 » Tue Jul 18, 2017 3:43 pm

From you, "I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be."

Let me start out with a question - what are your parameters for a ideal perfect portfolio. It seems at first blush you are throwing a plate of spaghetti at the wall and see what sticks.

For example "Exposure to undiscovered factors through actively managed holdings". Probably not. We can list those factors. Active management can produce alpha. How are you going to chose your active management? It is not like indexing where you just buy everything.

Here is another example:
TD2626 wrote: 30% Vanguard Total World Stock Index Fund
10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
You have duplication here. The Fidelity positions more or less mirror the Vanguard fund. They could be combined. If you wanted to overweight then you could go down to 2 funds. No reason to have 3.

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TD2626
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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 3:45 pm

willthrill81 wrote:
TD2626 wrote:Having a small allocation to active, as is shown here
TD2626 wrote:3% Vanguard Wellington Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
3% Vanguard STAR Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
2% Dodge and Cox Stock Fund
2% Vanguard Strategic Equity Fund (VSEQX)
2% Vanguard Equity Income Fund Investor Shares (VEIPX)
is based on ideas I discussed here: viewtopic.php?f=10&t=221271#p3415505 - that having 5-10% of the portfolio in low cost active may make an improvement

The ~30 individual stocks are due to the cost and tax loss harvesting advantages discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Individual stocks have no expense ratio and have TLH opportunities.
Having 10% (subtracting the 2% of STAR in bonds) of the portfolio in actively managed stocks isn't likely to make a significant difference in your portfolio. If it outperforms the other stocks by 10%, which is unlikely to occur over the long-term, then your portfolio would have benefited by only 1%.

You'd be better off sticking the 5% devoted to cash and alternatives in a stock index fund, unless your holding them for security, in which case STT or ITT would work fine.
I feel as though the smaller allocations would serve to reduce fat tail risk / black swan risk. If there was some sort of problem with the main index funds that make up most of the portfolio - or if there was a problem with indexing in general - having the active funds could save the day.

The cash allocation is intended for safety, in case the roof caves in (literally). I tend to advocate inclusion of an emergency fund into AA, with the stipulation that the cash allocation must also be >6 months in expenses. The cash allocation is also intended to somewhat temper the fairly risky investments elsewhere in the portfolio.

delamer
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Re: The Quest for Perfection

Post by delamer » Tue Jul 18, 2017 3:47 pm

If you want to diversify among investment firms, you can hold the same funds/ETFs at a couple different firms. It would make a lot more sense than tracking all these assets and dealing with rebalancing, particularly in a taxable account.

Thesaints
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Re: The Quest for Perfection

Post by Thesaints » Tue Jul 18, 2017 3:48 pm

TD2626 wrote: I feel as though the smaller allocations would serve to reduce fat tail risk / black swan risk. If there was some sort of problem with the main index funds that make up most of the portfolio - or if there was a problem with indexing in general - having the active funds could save the day.
... or make it a lot worse.

KlangFool
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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 3:50 pm

TD2626 wrote:
I feel as though the smaller allocations would serve to reduce fat tail risk / black swan risk. If there was some sort of problem with the main index funds that make up most of the portfolio - or if there was a problem with indexing in general - having the active funds could save the day.
TD2626,

It is simple math. If the main index funds have a problem, how much your active fund need to go up in order to matter? At your current percentage, it would not help.

Ditto, you could do the same calculation for all your other holdings. Then, you will be down to 5 or 6.

KlangFool

KlangFool
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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 3:56 pm

OP,

I have

1) Wellington Fund

2) International stock index

3) US stock index fund

4) Total bond market Index fund

5) Small Cap Value Index fund

6) Intermediate-term treasury bond fund

6 funds.

KlangFool

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willthrill81
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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 3:58 pm

TD2626 wrote:
willthrill81 wrote:You don't need municipal bonds unless (1) the bonds are in a taxable account and (2) you are in the highest income tax brackets. Similarly, high yield bonds are not necessary, especially at such a small allocation in the total portfolio.

What do you mean by "overwhelmingly based on globally cap weighted equities?" Either a portfolio is globally cap weighted or it isn't. If you just bought a world stock fund, you would always be globally cap weighted. By buying US and international separately, you may lose this weighting over time.
Many, if not most, investors are in the 25% bracket. Theory suggests that the 25% tax bracket is the break-even point where the after tax yield between munis and taxable bonds is roughly equal.
The decrease in yield between muni and taxable is generally greater than 25%. Usually, you need to be well above a 30% tax rate for munis to make sense.
TD2626 wrote:The desire for diversification would suggest holding both - diversification is the only free lunch due to Modern Portfolio Theory (low correlation between risks affecting municipalities vs corporations could improve portfolio Sharpe ratio).
The added diversification in this case is minimal.
TD2626 wrote:Regarding the global cap weighting - much of the portfolio is globally cap weighted. However, there are mild tilts. The 30% total world would drift with the US's share of the global stock market, while the 10% Total US / 10% Total International would be re-balanced routinely to ensure that the portfolio does not get too overwhelmingly US-based or International-based.
So why not just hold a world stock fund and then tilt toward SCV and EM?
TD2626 wrote:I feel as though the smaller allocations would serve to reduce fat tail risk / black swan risk. If there was some sort of problem with the main index funds that make up most of the portfolio - or if there was a problem with indexing in general - having the active funds could save the day.
No, no, no. 10% of the portfolio being actively managed stocks isn't going to 'save the day' when the other 75% are in indexes in the event of a black swan. Not one chance in a thousand.
TD2626 wrote:The cash allocation is intended for safety, in case the roof caves in (literally). I tend to advocate inclusion of an emergency fund into AA, with the stipulation that the cash allocation must also be >6 months in expenses. The cash allocation is also intended to somewhat temper the fairly risky investments elsewhere in the portfolio.
For the purposes of evaluating your portfolio, I would separate your EF from your invested portfolio. It just makes it easier to see what's going on.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Pajamas
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Re: The Quest for Perfection

Post by Pajamas » Tue Jul 18, 2017 4:00 pm

If you can't make a list of your holdings from memory, your portfolio is probably too complicated.

There is probably a lot of overlap between the funds you listed.

Also, 0.05% of $3 million is $1,500. What use is that amount of anything in a $3 million portfolio? Especially currency or "several kinds" of precious metals? Gold is over $1,200 an ounce today and platinum is over $900 an ounce, so you wouldn't even be able to hold a full ounce of each.

alex_686
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Re: The Quest for Perfection

Post by alex_686 » Tue Jul 18, 2017 4:10 pm

TD2626 wrote:I feel as though the smaller allocations would serve to reduce fat tail risk / black swan risk. If there was some sort of problem with the main index funds that make up most of the portfolio - or if there was a problem with indexing in general - having the active funds could save the day.
Don't worry about the back swan here. Black swans exists but they would hit index and actively manged funds alike. I can think of some edge cases in the bond market and emerging markets that could lead to sub-par performance.

CantPassAgain
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Re: The Quest for Perfection

Post by CantPassAgain » Tue Jul 18, 2017 4:17 pm

Are you serious? In the not likely event you aren't just trying to rile up stodgy old bogleheads I'll drop this line here, one of my favorites:

"The enemy of a good plan is the search for a perfect plan."

Avo
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Re: The Quest for Perfection

Post by Avo » Tue Jul 18, 2017 4:21 pm

TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be.
This is the whole subject of modern portfolio theory, the efficient frontier, factor-based investing, etc. You are very far from this!

You seem to have the idea that tossing in a little bit of this and a little bit of that somehow improves returns and/or lowers risk. This is wrong!

For example, one theoretically ideal portfolio is an all-world cap-weighted stock fund like VT.

That's it. Nothing else. If you can tolerate the volatility of this portfolio, it's already perfect. Nothing can be done to improve it, according to MPT.

If you're worried about custodian risk, hold it at two or more different custodians.

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TD2626
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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 4:23 pm

KlangFool wrote:1) Write one paragraph per holding and explain why and how it makes any difference.
Thanks for the feedback. I'll try to justify each holding.
TD2626 wrote:
Stocks (85% total):

30% Vanguard Total World Stock Index Fund
Total world is designed to provide globally cap weighted exposure to nearly all available equities. It is the portfolio's largest single holding.

10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
These are intended to mirror Vanguard Total world, but at a different firm and with a different management structure. Could provide easier access to funds temporarily if Vanguard is experiencing issues. There are slight differences - this portion is fixed at 50/50 international to domestic, to reduce exposure to scenarios like the Japanese asset price bubble where one country became a large portion of the global market - then crashed.

5% Vanguard Small Cap Value Index Fund
This puts in place a small tilt towards small-value. Small Vaue tilting is discussed here: https://www.bogleheads.org/wiki/Value_tilting_-_stock

5% Vanguard Emerging Markets Stock Index Fund
This puts in place a small tilt towards EM, for diversification and increased total return at the cost of high risk.


15% Passive Individual Stock Portfolio: About 30 Mega-Cap, Large-Value Individual Stocks. Buy & Hold Forever. Each should be about 0.5% of portfolio. Mostly Dow Stocks.
This is intended to reduce portfolio expense ratio while also providing tax loss harvesting opportunities, as is discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Holdings that are less than 5% of the overall portfolio is a requirement of this strategy; indeed, it would be very risky to have 5% of a portfolio in a single stock.


3% Vanguard Wellington Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
3% Vanguard STAR Fund (Note – about 1% of this is in bonds, so only about 2% is in stocks for 3% of portfolio total)
2% Dodge and Cox Stock Fund
2% Vanguard Strategic Equity Fund (VSEQX)
2% Vanguard Equity Income Fund Investor Shares (VEIPX)
Having an allocation to active is based on ideas I discussed here: viewtopic.php?f=10&t=221271#p3415505 that having 5-10% of the portfolio in low cost active may make an improvement based on expected alpha and the low correlation of that alpha to beta. Having multiple active funds is needed to diversify away individual manager risk.

Bonds (10% total):
2.5% Vanguard Total Bond Index Fund
0.75% Vanguard Total International Bond Index Fund
1% National Long-Term Muni Bond Fund, with lower credit quality
1% State-Specific Long-Term Muni Bond Fund
These provide reasonable exposure to most of the bond market. Total bond does not provide enough long term bonds for my liking but it is the base of the bond portfolio. It also provides exposure to MBS securities and short/intermediate term bonds. Diversification into municipal bonds is also helped by the two muni funds. One would not want all muni bonds to be from a single state - but a tilt to one's home state is reasonable.

0.75% Vanguard Long Term Vanguard Long-Term Government Bond Index Fund Admiral Shares (VLGSX)
0.75% Vanguard Long-Term Corporate Bond Index Fund Admiral Shares (VLTCX)
The goal of this portion of the portfolio is to tilt bonds toward higher yeilding and higher total return securities. I believe that the long term bonds provide some of the best diversification benefits from holding bonds (long term treasureries are often thought to have some of the lowest correlations with equities, for example). This portion of the portfolio also provides substantial total return. I admit this is probably excess complexity. It could be reasonably combined into this single fund: https://personal.vanguard.com/us/funds/ ... undId=0522

0.25% Vanguard EM Gov’t Bond Fund
0.25% Vanguard High-Yield Corporate Fund Investor Shares (VWEHX)
These provide exposure to assets that one is not otherwise very much exposed to, at a reasonable rating. It increases total returns somewhat and provides exposure to credit risk. If bonds perform better than stocks for several decades, these could be the best portions of the portfolio.

0.5% CD at a local bank with >6 month maturity
0.25% Paper iBonds
These provide some safety but are considered bonds in this construction. It is more intended as emergency fund type assets.

(2% Bond Exposure from Active Funds Listed in Stocks)
This is an integral part of the strategy of having exposure to active management in the portfolio.

Cash and Alternatives (5% total):
2% HY Savings Accounts (3, at different banks, some online, but several brick and mortar)
1% Checking Accounts (2, at different banks, at least two brick and mortar)
1% Money Market Funds (2)
0.9% CD at a local bank with <6 month maturity
0.05% Precious Metals (several kinds)
0.05% Currency
This is primarily a "emergency fund" portion of the portfolio. Many of the funds are needed. For example, brokerage accounts at Vanugard and Fidelity require two core money market funds. Checking accounts are essentially needed for direct deposit and life - and some currency holdings seem reasonable in case ATMs are closed or banks are down. Much of this is also designed to help one sleep well at night with a diverse array of safe assets.

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Re: The Quest for Perfection

Post by retiredjg » Tue Jul 18, 2017 4:26 pm

TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be. Please poke holes in one iteration of my thinking.
To me it appears to be a collection of "good funds". I don't see it as a well thought out portfolio plan.

There is a lot of overlap, much of it non-sensical. It would be a nightmare to manage even if all in one account. Spread it out over a couple of work plans and it is probably not even possible to achieve.

I'm sorry to be so negative, but you did ask for opinions and I don't see much good about this other than it is pretty low cost.

Edited to add....your justification for each holding sounds reasonable. The problem is that most of that stuff simply does not matter.
Last edited by retiredjg on Tue Jul 18, 2017 4:39 pm, edited 2 times in total.

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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 4:33 pm

Avo wrote:
TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be.
This is the whole subject of modern portfolio theory, the efficient frontier, factor-based investing, etc. You are very far from this!

You seem to have the idea that tossing in a little bit of this and a little bit of that somehow improves returns and/or lowers risk. This is wrong!

For example, one theoretically ideal portfolio is an all-world cap-weighted stock fund like VT.

That's it. Nothing else. If you can tolerate the volatility of this portfolio, it's already perfect. Nothing can be done to improve it, according to MPT.

If you're worried about custodian risk, hold it at two or more different custodians.
Thank you so much for the feedback, it is much appreciated.

I very much like VT - and based the portfolio idea around it. However, I added some small tilts, like SCV and EM, as well. The 10% bond allocation is in recognition of the fact that for some 20+ year periods, bonds can outperform stocks - but only if one's bonds are long term bonds like are described in the list of funds.

It would be unnerving to, for example, have zero exposure to municipal bonds if I only had Total Bond. What if the municipal bond market outperforms the corporate bond market? Also, High Yield and foreign bonds are not well represented by total bond, so these funds are also included as a small allocation. I discussed more on my feelings regarding High Yeild bonds and this issue here: viewtopic.php?f=10&t=220909&p=3405372#p3405372

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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 4:36 pm

TD2626 wrote:The 10% bond allocation is in recognition of the fact that for some 20+ year periods, bonds can outperform stocks - but only if one's bonds are long term bonds like are described in the list of funds.
Historically, the likelihood of that happening is very small, and at thirty years, it's only happened once in the last 150 years, and just barely at that.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:37 pm

TD2626 wrote:
KlangFool wrote:1) Write one paragraph per holding and explain why and how it makes any difference.
Thanks for the feedback. I'll try to justify each holding.
TD2626 wrote:
Stocks (85% total):

A) 30% Vanguard Total World Stock Index Fund
Total world is designed to provide globally cap weighted exposure to nearly all available equities. It is the portfolio's largest single holding.

B) 10% Fidelity Total US Stock Index Fund
10% Fidelity Total International Stock Index Fund
These are intended to mirror Vanguard Total world, but at a different firm and with a different management structure. Could provide easier access to funds temporarily if Vanguard is experiencing issues. There are slight differences - this portion is fixed at 50/50 international to domestic, to reduce exposure to scenarios like the Japanese asset price bubble where one country became a large portion of the global market - then crashed.

TD2626,

Those are index funds. There is no management. You either go with (A) or (B). If you go with (B), you pick the same 2 Vanguard funds as the Fidelity equivalent. If (A) does not exist with Fidelity, you go with (B). Instead of 3 funds, you have 2 identical funds with 2 separate brokerage accounts.

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:38 pm

OP,

You only have 10% in bond. You are only allowed 2 bond funds. Pick 2.

KlangFool

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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 4:40 pm

I realize that simplicity - say, holding only 3 funds - is nice, and reduces stress and work managing a portfolio. I am simply worried that having a portfolio that is, say, 100% Total World wouldn't be as good as a more complex portfolio like this one that is based on index funds, is quite low cost, and also has exposure to a variety of other assets.

Mabye a "perfect portfolio" could start at 100% total world, and then add small SCV, EM, tilts, add a small bond allocation for safety and total return, and stop? Or should one just keep adding each reasonable idea until the portfolio includes all of them, while still keeping most assets in Total World?

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:42 pm

OP,

<<15% Passive Individual Stock Portfolio: About 30 Mega-Cap, Large-Value Individual Stocks. Buy & Hold Forever. Each should be about 0.5% of portfolio. Mostly Dow Stocks.
This is intended to reduce portfolio expense ratio while also providing tax loss harvesting opportunities, as is discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Holdings that are less than 5% of the overall portfolio is a requirement of this strategy; indeed, it would be very risky to have 5% of a portfolio in a single stock.>>

This is a duplicate of active stock management portion of Wellington fund. Unless you can prove to us that you are a lot better than Wellington management company, don't waste your time. And, if you can prove to others that you are better than Wellington management, you should start a hedge fund.

KlangFool

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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 4:42 pm

KlangFool wrote:OP,

You only have 10% in bond. You are only allowed 2 bond funds. Pick 2.

KlangFool
If I had to pick two bond funds, I'd go with:

5% Vanguard Total Bond
5% Vanguard Long-Term Bond Index Fund (VBLTX)

This would probably accomplish most of the same objectives with somewhat higher simplicity.

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:44 pm

TD2626 wrote:I realize that simplicity - say, holding only 3 funds - is nice, and reduces stress and work managing a portfolio. I am simply worried that having a portfolio that is, say, 100% Total World wouldn't be as good as a more complex portfolio like this one that is based on index funds, is quite low cost, and also has exposure to a variety of other assets.

Mabye a "perfect portfolio" could start at 100% total world, and then add small SCV, EM, tilts, add a small bond allocation for safety and total return, and stop? Or should one just keep adding each reasonable idea until the portfolio includes all of them, while still keeping most assets in Total World?
TD2626,

<<also has exposure to a variety of other assets.>>

Your portfolio has less exposure than a simple portfolio. It has a lot of overlap and duplicates.

KlangFool

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Re: The Quest for Perfection

Post by SimpleGift » Tue Jul 18, 2017 4:45 pm

TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be.
You'd be much better off long-term if you just stuck to the 6 asset sub-classes in your avatar image. :wink:

Believe me, 30 years down the road, when your mental faculties start to slow down, and you've got a whole menagerie of funds with large embedded capital gains (making simplification impractical at that point), you’ll wish you'd started out with a simpler portfolio.
Cordially, Todd

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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 4:48 pm

TD2626 wrote:I realize that simplicity - say, holding only 3 funds - is nice, and reduces stress and work managing a portfolio. I am simply worried that having a portfolio that is, say, 100% Total World wouldn't be as good as a more complex portfolio like this one that is based on index funds, is quite low cost, and also has exposure to a variety of other assets.
It is literally impossible to know if this monstrosity would outperform a 3 fund (or 5 fund if you tilted toward SCV and EM) without a working crystal ball. It seems unlikely though.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:48 pm

TD2626 wrote:
KlangFool wrote:OP,

You only have 10% in bond. You are only allowed 2 bond funds. Pick 2.

KlangFool
If I had to pick two bond funds, I'd go with:

5% Vanguard Total Bond
5% Vanguard Long-Term Bond Index Fund (VBLTX)

This would probably accomplish most of the same objectives with somewhat higher simplicity.
TD2626,

Yes on total bond. Bad idea on any long-term bond index fund. Long-term bond has a higher risk than short-term bond but lower return than stock. It has about the same level of risk as stock. It does not fit anywhere in a portfolio. Why take more or same risk as stock but get less return?

Larry has a good book on this subject. Could someone else please post what that book is?

KlangFool

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Re: The Quest for Perfection

Post by RadAudit » Tue Jul 18, 2017 4:51 pm

TD2626 wrote:Disclaimer - note that this is completely hypothetical, is not a suggestion, and may not even be a good idea. It simply represents the results of my thinking on what a complete portfolio could look like. This is what happens when I overthink things…. Anyway, here goes:
I admire your tenacious pursuit of the ideal portfolio in the face of contrary opinions. Probably the best approach to answering the question at hand - when all else fails - is to invest in the ideal portfolio. Let us know how it works out.

Personally, I gave up on looking for the perfect portfolio some time ago and settled for good enough - right after a came across the saying about one thing that can wreck a good plan is the search for a perfect plan.

Best of luck.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The calvary isn't coming, kids. You are on your own.

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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 4:51 pm

KlangFool wrote:OP,

<<15% Passive Individual Stock Portfolio: About 30 Mega-Cap, Large-Value Individual Stocks. Buy & Hold Forever. Each should be about 0.5% of portfolio. Mostly Dow Stocks.
This is intended to reduce portfolio expense ratio while also providing tax loss harvesting opportunities, as is discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Holdings that are less than 5% of the overall portfolio is a requirement of this strategy; indeed, it would be very risky to have 5% of a portfolio in a single stock.>>

This is a duplicate of active stock management portion of Wellington fund. Unless you can prove to us that you are a lot better than Wellington management company, don't waste your time. And, if you can prove to others that you are better than Wellington management, you should start a hedge fund.

KlangFool
I guess that one could eliminate 15 holdings by reducing the number of individual stocks from 30 to 15. I could also reduce risk by making individual stocks be, say, 5% or 10% of the portfolio in total instead of 15%.

I think that this could provide a bit more control. One can decide to realize capital gains in times of low income from one's job, in order to minimize taxes paid, for example. Also, one can tilt towards dividend stocks in order to have the convenience of regular income checks. If one trades very infrequently (average holding period >25 years) then the ultra-low turnover would provide benefits beyond holding a mutual fund. Additionally, holding stocks directly (via, for example, paper certificates) reduces black swan risk. One doesn't have to worry about SIPC coverage (which covers giving stock certificates to a broker for safekeeping) if holding certificates directly. It is not intended to outperform the index fund, indeed, it is only hoped that this will keep up with the index. This strategy is intended to be passive, and is not directly comparable to Wellington's active management strategy in my opinion.

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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 4:56 pm

KlangFool wrote:Long-term bond has a higher risk than short-term bond but lower return than stock. It has about the same level of risk as stock.
From 1978 until now, the TSM had a std. dev. of 15.23%, while LTT's was 11.06%. TSM had a worst year loss of -37.4%, while LTT was -13.03%. I would not call that the "about the same level of risk."
KlangFool wrote:It does not fit anywhere in a portfolio.
That's simply too harsh. I'm not a big fan of long-term bonds either, but there are certainly portfolios out there where they can make sense. David Swensen's "unconventional" portfolio has a 15% allocation to LTT, which is balanced out with 15% in TIPS.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 4:59 pm

TD2626 wrote:
KlangFool wrote:OP,

<<15% Passive Individual Stock Portfolio: About 30 Mega-Cap, Large-Value Individual Stocks. Buy & Hold Forever. Each should be about 0.5% of portfolio. Mostly Dow Stocks.
This is intended to reduce portfolio expense ratio while also providing tax loss harvesting opportunities, as is discussed here: https://www.bogleheads.org/wiki/Passive ... ual_stocks. Holdings that are less than 5% of the overall portfolio is a requirement of this strategy; indeed, it would be very risky to have 5% of a portfolio in a single stock.>>

This is a duplicate of active stock management portion of Wellington fund. Unless you can prove to us that you are a lot better than Wellington management company, don't waste your time. And, if you can prove to others that you are better than Wellington management, you should start a hedge fund.

KlangFool
I guess that one could eliminate 15 holdings by reducing the number of individual stocks from 30 to 15. I could also reduce risk by making individual stocks be, say, 5% or 10% of the portfolio in total instead of 15%.

I think that this could provide a bit more control. One can decide to realize capital gains in times of low income from one's job, in order to minimize taxes paid, for example. Also, one can tilt towards dividend stocks in order to have the convenience of regular income checks. If one trades very infrequently (average holding period >25 years) then the ultra-low turnover would provide benefits beyond holding a mutual fund. Additionally, holding stocks directly (via, for example, paper certificates) reduces black swan risk. One doesn't have to worry about SIPC coverage (which covers giving stock certificates to a broker for safekeeping) if holding certificates directly. It is not intended to outperform the index fund, indeed, it is only hoped that this will keep up with the index. This strategy is intended to be passive, and is not directly comparable to Wellington's active management strategy in my opinion.
TD2626,

1) Please read the fund prospectus of Wellington fund. You are doing exactly as described by Wellington management.

<< for example. Also, one can tilt towards dividend stocks in order to have the convenience of regular income checks.>>

2) S&P 500 index fund is paying 2% to 3% dividend.

A) If your portfolio is big enough, S&P 500 index fund is all you need.

B) If your portfolio is not big enough, how does 15% of your portfolio in dividend stock helps you? Even if your dividend stock is paying 10% dividend (unlikely), it won't matter.

KlangFool

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Re: The Quest for Perfection

Post by TD2626 » Tue Jul 18, 2017 5:00 pm

Simplegift wrote:
TD2626 wrote:I have been trying to figure out what a theoretically ideal/perfect hypothetical portfolio might be.
You'd be much better off long-term if you just stuck to the 6 asset sub-classes in your avatar image. :wink:

Believe me, 30 years down the road, when your mental faculties start to slow down, and you've got a whole menagerie of funds with large embedded capital gains (making simplification impractical at that point), you’ll wish you'd started out with a simpler portfolio.
I've been meaning to write up a post explaining the whole avatar, but the avatar is actually a small segment of a giant hierarchy chart that includes far more sub-levels (a few dozen). For example, the tax-exempt bond fund has a branch coming off it for state specific and a branch for national. I couldn't include the whole chart in the avatar and still have it legible.

The hierarchy chart helps me focus on the fact that the whole portfolio at the top is the most important thing to think about. The next row, stocks/bonds/cash, is the next most important. Then, major sub-allocations like domestic vs international are important, but are lower on the priority list.

I feel the hierarchy chart (google hierarchy chart) is a better way of representing a portfolio and organizing it theoretically than a pie chart.

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 5:01 pm

willthrill81 wrote:
KlangFool wrote:Long-term bond has a higher risk than short-term bond but lower return than stock. It has about the same level of risk as stock.
From 1978 until now, the TSM had a std. dev. of 15.23%, while LTT's was 11.06%. TSM had a worst year loss of -37.4%, while LTT was -13.03%. I would not call that the "about the same level of risk."
KlangFool wrote:It does not fit anywhere in a portfolio.
That's simply too harsh. I'm not a big fan of long-term bonds either, but there are certainly portfolios out there where they can make sense. David Swensen's "unconventional" portfolio has a 15% allocation to LTT, which is balanced out with 15% in TIPS.
willthrill81,

I do not advise folks to invest in an asset class that I am not convinced enough to invest in.

KlangFool

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Re: The Quest for Perfection

Post by willthrill81 » Tue Jul 18, 2017 5:02 pm

KlangFool wrote:
willthrill81 wrote:
KlangFool wrote:Long-term bond has a higher risk than short-term bond but lower return than stock. It has about the same level of risk as stock.
From 1978 until now, the TSM had a std. dev. of 15.23%, while LTT's was 11.06%. TSM had a worst year loss of -37.4%, while LTT was -13.03%. I would not call that the "about the same level of risk."
KlangFool wrote:It does not fit anywhere in a portfolio.
That's simply too harsh. I'm not a big fan of long-term bonds either, but there are certainly portfolios out there where they can make sense. David Swensen's "unconventional" portfolio has a 15% allocation to LTT, which is balanced out with 15% in TIPS.
willthrill81,

I do not advise folks to invest in an asset class that I am not convinced enough to invest in.

KlangFool
Just because you don't personally invest in something does not mean that you should hold it in disdain and advise people as such.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Quest for Perfection

Post by KlangFool » Tue Jul 18, 2017 5:03 pm

OP,

If you really care and worry about Black Swan, you should have some real physical gold. I kept some Gold jewelry for that reason.

KlangFool

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