How to build a lazy portfolio

Investors are often challenged to select funds from a long list of unfamiliar names. For example, selecting funds for an employer's retirement plan when starting a new job.

Alternatively, an investor may know which funds to utilize, but does not understand how to assign the percentage contribution for each fund in the portfolio (see below).

Whether an investor adheres to a philosophy of investing in the total market using a minimum number of funds, or pursues a more advanced strategy of multifactor investing, it is possible to create what's known as a lazy portfolio.

Lazy portfolios are designed to be indexed portfolios which are appropriate: Lazy portfolios are meant to be buy-hold-and-rebalance portfolios.
 * For new investors: simple two-fund, three-fund, or four-fund portfolios built with total market index funds, to gain asset diversity.
 * For experienced investors: multifactor ("Slice and dice") portfolios that contain six or more index funds targeting market, size and value factors.

Select your 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.

Analyze the fund list
A general checklist when examining fund options:


 * For each item in the 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.


 * The general approach for total market investors is to look for the major categories, such as US stock, international stock, US bonds, and international bonds. Fixed income (cash reserves) counts as bonds; company stock funds count as stock. Some bond funds may be listed as "inflation protected." 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. (Open table to view fund options and expense ratios.)

In this instance, the investor has the option of selecting a lazy portfolio of indexed target retirement funds or fashioning a lazy portfolio from the following stand-alone index funds:


 * Investors desiring to create multifactor portfolios will want to also find funds (optimally indexed) that provide exposure to small cap and value stocks in both US and international markets.


 * For asset allocations, it's only necessary to get the percentages to the nearest 5 %.

Target date retirement funds
The default option for employer provider plans is to place your contributions and employer matches into a target date retirement fund. If you are a novice investor and the process of selecting funds is too complicated, then staying with a target date retirement fund may be entirely suitable for you. Select the fund which matches your desired asset allocation.

However, many retirement date funds use a large number of actively managed funds. If these funds are available at a modest expense ratio, this may be a satisfactory option. but 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.

Select the funds
The first step in fund selection within your employer retirement plan is to look for choices that have the word "index" in them, such the "SSgA S&P 500 Index" fund or "SSgA US Bond Index" (US Bonds) or "SSgA Global Equity Ex US Index" (there may be an alphabet soup of acronyms here, such as MSCI EAFE. The asset allocation information from the fund fact sheet will tell you what this fund is for, i.e. international stock). Index funds will generally be your lowest cost funds. 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.)

An actively managed fund ("index" is not in the fund name) will generally have higher costs than an equivalent index fund.

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.

If your plan provides no index funds select the lowest cost funds for stock fund choices and select the highest grade bond funds. 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:

If you are looking to build a multifactor portfolio, and you do not have small cap and value index funds available in the employer plan, look for a total market or S&P 500 index fund for market factor exposure, and use other accounts for small cap and value factor exposure. The plan may also contain suitable bond funds for filling bond allocation requirements.

U.S. stocks
If you are a total market investor you may not be able to approximate the total stock market with the available choices, but do the best you can. An S&P 500 index fund should be adequate on its own if you can't find (or don't want the added complexity of) small-cap and mid-cap funds.

A completion index fund can be used to complement an S&P 500 fund. These two funds will provide exposure to the total US stock market. If a completion index is not available in the employer plan the investor may need to place these allocations in personal retirement plans or taxable accounts.

A multifactor investor may not have small cap and value index funds in the employer provided plan. The investor may need to place these allocations in personal retirement plans or taxable accounts.

Select the allocation percentages
Now that the funds you will be using in your plan have been identified, you must allocate them according to your asset allocation targets. The following two examples show how one might make these allocations in the context of your retirement plan.

Total market investors
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 article for a comprehensive overview. The following example outlines the basic approach.

If you have decided on an asset allocation of 60% stocks / 40% bonds, Vanguard's target retirement funds list shows that the Vanguard Target Retirement 2020 Fund (VTWNX) is  close to what you are looking for. Under Portfolio and Management:


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

! Ranking by Percentage !! Fund !! Percentage !! Round to the nearest 5%
 * + Vanguard Target Retirement 2020 Fund (VTWNX) Asset Allocation as of August 31, 2013
 * 1 ||align="left"|Vanguard Total Stock Market Index Fund Investor Shares (US Stocks) ||43.6% ||40%
 * 2 ||align="left"|Vanguard Total Bond Market II Index Fund Investor Shares (US Bonds) || 30.3%|| 30%
 * 3 ||align="left"|Vanguard Total International Stock Index Fund Investor Shares (International Stocks) ||18.5% || 20%
 * 4 ||align="left"|Vanguard Total International Bond Index Fund Investor Shares (International Bonds) || 7.6% ||10%
 * Total|| —||100.0% ||100%
 * }
 * 4 ||align="left"|Vanguard Total International Bond Index Fund Investor Shares (International Bonds) || 7.6% ||10%
 * Total|| —||100.0% ||100%
 * }
 * Total|| —||100.0% ||100%
 * }


 * 60% Stocks = 40% US Stocks + 20% International Stocks
 * 40% Bonds = 30% US Bonds + 10% International Bonds

If you don't have, or don't want to have international bonds, just combine it with the total bonds allocation.

Select whichever asset class indexed funds are available in the employer retirement plan to fill these allocations and use other accounts to fill out the allocation.

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.

Multifactor ("slice and dice") investors
Using the Coffeehouse Portfolio as a template for a sample multifactor portfolio and utilizing Vanguard funds for a 60% stocks / 40% bonds allocation, you might allocate a portfolio as follows:

Select whichever asset class indexed funds are available in the employer retirement plan to fill these allocations and use other accounts to fill out the allocation.

Multiple accounts
If you have a partner, 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. For guidance on handling these more complex scenarios, see Asset allocation in multiple accounts.