If you’re interested in choosing your own investments, but think that David Swensen’s asset allocation model takes too much work to maintain, then this simpler option might be for you.
It’s called the Core Four Portfolio. It contains just four funds, as opposed to Swensen’s six funds.
So how do you build this portfolio?
Choose Your Bond Allocation
First, decide how much you want in bonds. Since bonds don’t always move in the same direction as stocks, adding them will help balance part of your portfolio.
Don’t know how much you should put in bonds?
A rough guide to follow is that bonds should equal your age. So if you’re 30 years old, you should consider putting 30 percent of your money in bonds.
By the time you turn 50 years old, the bond portion of your portfolio also should’ve slowly increased - by 1 percent each year - to make up 50 percent of your portfolio. Of course, you can increase the amount you have in bonds if you don’t want to take on as much risk, or decrease the amount if you want to be more aggressive.
So which fund should you include for your bond allocation?
Vanguard Total Bond Market Index Fund (VBMFX)
This is a quality bond fund that’s great for most investors. Made up of about 10,000 individual bonds - most of which are U.S. Treasury, mortgage, and corporate bonds - this fund provides plenty of diversification at a low cost.
Your remaining money should be allocated towards stocks.
Subdividing Your Stock Allocation
To keep your portfolio as diversified as possible, its important that your stock allocation includes different subcategories. Here’s a deeper look into the reason why.
Different types of stocks perform differently at any given time. You don’t want your portfolio to have all of its stock investments in a losing asset class. That’s why you want to have as many types of stocks as is practical to own.
The following three different stock funds will provide the diversification that you need.
Vanguard Total Stock Market Index Fund (VTSMX)
This is a great fund because it closely resembles the entire U.S. stock market. What does this fund include?
Morningstar’s Instant X-Ray tool shows how your portfolio’s funds are divided between the different sizes and valuations.
As you can see, large-cap stocks make up most of the U.S. stock market.
Make this 70 percent of your stock allocation.
Vanguard Total International Stock Index Fund (VGTSX)
U.S. stocks make up about half the value of the entire world’s stocks, and international stocks make up the other half. Since international stocks tend to perform differently than U.S. stocks and have a chance to provide higher returns, adding them to your stock allocation will provide even more diversification than if you had just a portfolio made up of U.S. stocks.
Make this 20 percent of your stock allocation.
Vanguard REIT Index Fund (VGSIX)
Real Estate Investment Trusts (REITs) are a special type of fund, and are thought of as a separate asset class from stocks and bonds because they often perform differently than other stocks. This difference is good for diversification, making it another useful addition to your portfolio.
Make this 10 percent of your stock allocation.
Putting Everything Together
Here’s an example that shows you how to actually build this portfolio.
Let’s say you’re 40 years old, and you decide to put 40 percent of your money in bonds. That means that the remaining 60 percent of your money will be put in stocks.
Since you have three different stock funds to invest in, you’ll need to divide up the 60 percent of your money among the three stock funds. Here’s the math that shows how to do this:
- 70 percent of Vanguard Total Stock Market Index Fund (VTSMX) x 60 percent of your money = 42 percent of your total money
- 20 percent of Vanguard Total International Stock Index Fund (VGTSX) x 60 percent of your money = 12 percent of your total money
- 10 percent of Vanguard REIT Index Fund (VGSIX) x 60 percent of your money = 6 percent of your total money
Here’s a table that shows the total allocation between stocks and bonds for both a a 60/40 (stock/bond) portfolio, and – if you want to take on more risk – an 80/20 portfolio.
Core Four Portfolio Performance
So how well did the Core Four Portfolio perform? Here’s a table that compares the performance between a 60/40 portfolio, an 80/20 portfolio, and the S&P 500 (as measured by the Vanguard 500 Index Fund). Results are as of December 31, 2012.
|Average Returns||60/40 Portfolio||80/20 Portfolio||S&P 500|
In addition to this, if you’d like to know how the Core Four Portfolio is expected to perform over the next 30 years, check out this post here.
And if you’d like to get updates on how I’m implementing the Core Four Portfolio to grow my own net worth (and more importantly, to inspire you to do the same), enter your best email in the box below and click the “Subscribe” button.