In our book we ran the num­bers on a num­ber of experts’ port­fo­lios. All of them are rea­son­able: amply diver­si­fied across equi­ties and fixed income, with global cov­er­age. Some do bet­ter over cer­tain peri­ods of time, and worse over oth­ers. Some are riskier than oth­ers. But the long term returns fell within a fairly nar­row range.

Selected expert allo­ca­tions we ana­lyzed are as follows:

 

(The allo­ca­tions are straight from books, arti­cles or web sites. Returns data is from July 1990 to July 2010. The Malkiel allo­ca­tion reflects his rec­om­men­da­tion to over­weight China to reflect its sig­nif­i­cant con­tri­bu­tion to world GDP. “World allo­ca­tion” reflects per­cent­ages based strictly on mar­ket capitalization. All port­fo­lios are 60% equi­ties, 40% fixed income.)

Many invest­ment advi­sors imply that their asset allo­ca­tions are quite spe­cial, ever so well con­sid­ered and researched. But, when you peel back the onion, it becomes clear that there is no such thing as a per­fect port­fo­lio. As a mat­ter of fact, most of the experts included in this sur­vey explic­itly echo that sen­ti­ment in their books and other writ­ings. If you were to pick any one of the allo­ca­tions listed above, you should do about as well as the experts do.

Since index invest­ing can beat 99% of active investors over the long term, you would think it would be a lot harder, like brain surgery. Noth­ing could be fur­ther from the truth.

Fun­da­men­tally, index invest­ing involves mak­ing two deci­sions. First, you need to decide on an allo­ca­tion among asset classes. An asset class is sim­ply a cat­e­gory of invest­ment, for exam­ple US large cap­i­tal­iza­tion stocks (often referred to as “large cap”: those com­pa­nies whose mar­ket val­ues are the largest), devel­oped coun­try small stocks, munic­i­pal bonds, etc. Other com­mon asset classes that are eas­ily avail­able to ordi­nary investors are Real Estate Invest­ment Trusts (REITs) and commodities.

The sec­ond deci­sion is to pick low cost index funds to rep­re­sent those asset classes. Numer­ous stud­ies have shown that at least 90 per­cent of a portfolio’s return comes from asset allo­ca­tion, with the remain­ing 10 per­cent com­ing from the choice of index funds to imple­ment the allocation.

Better Returns Through Research

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(1) Analy­sis com­par­ing after tax per­for­mance of other advi­sors (or a self-managed, sophis­ti­cated investor) to 3 factor Indexing based on a glob­ally diver­si­fied port­fo­lio with a 60% equity, 40% fixed income allo­ca­tion. Ini­tial port­fo­lio val­ues assume the fol­low­ing: (a) $750K tax­able and $250k IRA with yearly addi­tions of $20k to tax­able account and $5k to IRA. (b)Taxes deducted via shares each April, assum­ing the high­est tax bracket for a Cal­i­for­nia investor. 

Past per­for­mance is not a pre­dic­tor of future performance.

3 factor Indexing has con­ducted exten­sive analy­sis con­cern­ing port­fo­lio per­for­mance. See “3 factor Indexing’s Method­ol­ogy and Invest­ment Risks” for details and dis­claimers regard­ing our state­ments con­cern­ing per­for­mance, and the var­i­ous assump­tions we have made in our analysis.