How to build a lazy portfolio

🇺🇸 This article will address how to incorporate the investment options in employer retirement plans to create a  lazy portfolio.

The process starts by deciding on a stock / bond asset allocation, reviewing the available funds, then selecting the appropriate funds to create the portfolio.

The article illustrates two asset allocation plans using a 60% / 40% stock to bond allocation:
 * For total market investors: A three-fund indexed portfolio;
 * For multifactor ("slice and dice") investors: The seven-fund indexed Coffeehouse portfolio.

Asset allocation
The first step when starting an investment program is to choose your asset allocation, basically your allocation to stocks, bonds, and cash. Be sure to consider this in the context of your entire portfolio. When beginning participation in an employer's retirement plan, this means incorporating both the plan investments and your existing investments in your overall allocations. The allocations should reflect your return needs balanced against your tolerance for risk. For most investors this will mean hopefully gaining returns that, in the long run, outpace inflation, while reducing the magnitude of short term investment losses to a level that allows the investor to remain invested without panic selling.

Document your chosen asset allocation in your investment policy statement, if you would not yet have completed it.

Sample portfolios
The following sample portfolios depict two different asset allocation plans. For illustrative purposes, each portfolio holds a 60 / 40 equity / bond allocation.

Three-fund portfolio (for total market investors)
The three-fund portfolio attempts to simplify the investing process by utilizing three total market index funds holding broadly diversified stock and bond investments. The portfolio is meant to be a buy-hold-and rebalance portfolio. The three asset classes required for this portfolio are listed below: For example, Forum discussion 401k investment offers the options displayed in the table below. The plan contains Vanguard target retirement funds and standalone fund selections, which are suitable for creating a three-fund portfolio. (Open table to view fund options and expense ratios.)

In this instance, the investor can capture the three fund portfolio by using the fund selections in the table below. Selecting a Vanguard target retirement fund would create a variant of the three-fund portfolio, as the funds' add an international bond index fund to the portfolio. Vanguard target date retirement funds are four-fund portfolios.


 * {| class=wikitable style="text-align:center"

! Ranking by Percentage !! Fund !! Percentage
 * + Three-fund portfolio
 * 1 ||align="left"|Total Stock Market Index (US Stocks) ||40%
 * 2 ||align="left"|Total Bond Market Index (US Bonds) || 40%
 * 3 ||align="left"|Total International Stock Index (International Stocks)|| 20%
 * Total|| —||100.0%
 * }
 * 3 ||align="left"|Total International Stock Index (International Stocks)|| 20%
 * Total|| —||100.0%
 * }
 * }


 * 60% Stocks = 40% US Stocks + 20% International Stocks
 * 40% Bonds = 40% US Bonds

Coffeehouse portfolio (for "slice and dice" investors)


The Coffeehouse Portfolio is a "slice and dice" portfolio which uses seven index funds allocated in a 60% stocks / 40% bonds allocation. The portfolio is meant to be a buy-hold-and rebalance portfolio. The following plan posted in the forum discussion: First 401(k) Advice contains options that partially fulfill the Coffehouse portfolio allocation. (Open table for a complete listing of fund choices and expense ratios.) The investor could use the following funds:

The investor would need to hold US value and US small value stocks in additional accounts. (Extended illustration in footnotes).


 * 60% Stocks = 10% US Stocks (6 entries - REITs count as US Stocks)
 * 40% Bonds = 40% US Bonds

Multiple accounts
A frequently encountered situation is that the investment portfolio is allocated to a multiplicity of accounts. For example, a husband and wife may both have employer provider plans, both have personal retirement plans, both have taxable accounts. This equals six accounts.

Even if you are a single individual, it is possible to accumulate accounts over an investing lifetime. For example an individual might accumulate a current employer provided plan, a rollover IRA holding the assets from a past job's 401(k) plan, a Roth IRA, and a taxable account. In this situation you would need to repeat the actions over the different accounts:


 * 1) Determine our overall asset allocation.
 * 2) Perform the checklist on the employer retirement plan as mentioned in the next section.
 * 3) Gather the expense ratio for each fund in each account, as well as the tax efficiency.
 * 4) If some accounts do not offer an asset class, or close alternative, then the accounts which do have that asset class should be filled first, with lower expense ratios taking priority.
 * 5) Fill in remainder of your total asset allocation with the lowest expense ratios from each account, taking into account the tax considerations.
 * 6) Add up the total amount for each asset class and ensure that your asset allocation is as desired.

Selecting the funds - Employer plan checklist
For the chosen asset allocation you then need to review the available funds and select the appropriate ones.

Employer plans can have many investment options, presenting investors with a long list of unfamiliar names. The following checklist can help you find the offerings that can help fill your desired asset allocations. For our sample portfolios, we would be looking for index funds matching our targeted asset classes.

Employer plan checklist
For each item in the plan fund list, find the available asset class exposure that the funds provide and their expense ratios. This information can usually be found in the fund's fact sheets.

Look for the major asset class categories, such as US stock, international stock, small cap stocks, value stocks and US bonds. Fixed income (cash reserves) counts as bonds; company stock funds count as stock. Some bond funds may be listed as "inflation protected."

Since our desired portfolios are indexed, seek out the plan's index funds, such as the "SSgA S&P 500 Index" (US stocks) or "SSgA US Bond Index" (US bonds) or "SSgA Global Equity Ex US Index" (International stocks, which sometimes have an alphabet soup of acronyms like MSCI EAFE). The fund's fact sheet will list the asset allocation information. For an example of a plan with a mixture of index funds and active funds on the plan fund menu, see the fund options in the plan revealed in Any good funds in this list, forum discussion. (Open table to reveal fund options and expense ratios.) (Extended illustration in footnotes).

Employer provided plans typically contain at least one or two index funds. Some plans may have a brokerage window that provides access to a wider selection of indexed investment options, but be sure to calculate the expected cost of utilizing this service, taking into account all fees that would apply and compare it to the cost of using the fund choices in the qualified plan in order to help guide the decision.

The plan may not provide total market index funds. A common example is a plan offering only an S&P 500 index fund. You may want to approximate the total market by using funds that "complete" the S&P 500 index. Similarly, plans often provide international exposure with a developed market index fund, which lacks the emerging market stocks and small cap international stocks included in international total market funds. (You may not need to replicate a total market fund for every asset class if you can hold total market funds in other accounts.)

If you decide to reconstitute a total market fund using multiple funds, you can find detailed information on how to approximate total market allocations at:
 * Approximating total stock market
 * Approximating total international stock market

The plan may only contain actively managed funds. In this circumstance one should select the lowest cost stock funds and highest grade bond funds that approximate the targeted assets classes. For example, 401k Choices Seem Expensive, forum discussion reveals a 401(k) plan offering only active funds. (Open table to reveal fund options and expense ratios).

In this instance, an investor could minimize costs and fashion a three fund portfolio of large cap US stocks, developed market international stocks, and an investment grade intermediate bond fund:

Note that if you hold multiple accounts, you need not hold each of your portfolio's asset classes within the employer plan, unless you prefer to mirror the allocation in each account. The allocations can be spread across accounts (as an example: holding the bond allocations in an employer plan; the US stock investments in a personal IRA, and holding international investments in a taxable account.)

Target date retirement funds
A good default option for employer provider plans is to place your contributions and employer matches into a target date retirement fund.

Some plans may provide you with target retirement plans with indexed target date funds which can provide you with a variant of the three-fund portfolio. Examples would include plans holding Vanguard target retirement funds and the Thrift Savings Plan target retirement fund series.

If you are thinking of using a target date fund be aware that many plans offer retirement date funds that invest in a large number of actively managed funds. You need to carefully check the underlying funds to see if they truly match your desired allocation.

An advantage of tax-deferred accounts is that you can transfer among the different funds without paying taxes on the gains. In other words, you are not stuck with this decision. There is no penalty for changing your mind later. If you feel more confident about lowering your expenses by going to separate low-cost funds at a later time, you are free to do so.

Using a target date fund to approximate a lazy portfolio
If you are a novice investor seeking to use a three-fund or four fund portfolio, Vanguard's Target date retirement funds can provide models for your portfolio since they are nothing more than lazy portfolios, utilizing total market index funds, designed and managed by investment professionals. Your decision is to simply align your desired asset allocations with the appropriate target retirement fund.

Refer to the main article for a comprehensive overview.

Inflation-protected securities
Bond funds identified as inflation-protected, like TIPS, are somewhat different than a conventional bond fund. Their purpose is to help diversify your portfolio further by providing some protection against inflation.

One Boglehead approach is to add inflation-protected securities to the bond portion of your portfolio, perhaps up to 50% of the bond allocation. The choice is arbitrary - from not using any inflation-protected fund up to 50% (or more). The decision is based on a level of comfort (can you sleep well at night) rather than one based on theory.