The Impregnable Portfolio For The Beginner Investor

While I know it may be hard to focus on investing basics with the tariffs and market right now, I still want to establish a set of articles that will help investors set up their long-term strategy, and in the face of a potential bear market why not take advantage of it in a diversified way.

In my first article I showcased my investment philosophy and some stocks I found promising. It was aimed at what Benjamin Graham called the “Enterprising Investor”. An investor who by putting in through amounts of research chooses securities with the hopes of doing better than average. Whenever someone says average in investing, they likely mean the future performance of the S&P 500(which has historically returned 10% average a year). This article is different. I absolutely completely understand and agree with the position of Warren Buffet and Benjamin Graham that most people should be “Defensive Investors”. That being said I wish more people would at least learn what a PE ratio is because I think stocks are fun to learn about. The defensive investor is one who seeks to achieve average results. Most people would not find the best use of their career to be learning all they can about businesses. Instead, they are better off working in various important fields where they possess both passion and aptitude. If they “invest” in themselves and find ways to earn a high income through their own skills, then they can “outperform” most investors in terms of wealth creation without having to achieve double the average investment returns. In effect, a doctor who consistently defensively invests can build up a small fortune (which is by no means the real fortune to be found in life) by utilizing Adam Smith. Comparative advantage is the economics term at play here. Comparative advantage is the idea that everyone can use their best skills relative to the rest in the market, to get paid well by others who are not as good at it. When everyone does this, each person ends up at the position where they are at least the most productive(and hopefully fulfilled), so everyone ends up better off because we end up producing as a society the most total valuable goods/services. Which is like why tariffs cause inflation and are anti free market capitalism. The actual point I am making is this, even though I do love investing, and fantasizing about hopefully leaving a track record of above average annual returns(like one of my friends Mekhi fantasizes about eating a culver’s burger), I fully recognize more important than seeking exceptional returns to building a comprehensive meaning of wealth, is doing something that you love, that is well compensated(hey why not), and by saving a lot of money each and every paycheck. So hopefully my goal here is to help a beginner investor not have to think so much about investing but still aim for solid returns, whatever the future or news may hold. It could be described as the lazy man’s portfolio and when investing it can pay handsomely to be lazy. Many studies show that the more you change your investments, the lower your returns tend to be. One must remember that defensive investing is not about being perfectly prepared for everything, but about getting satisfactory results from a simple, diversified, and consistent lifetime of investing. As to next year, anything can happen, the beginner investor must understand that in the short run assets are volatile, but in the long run are highly likely to produce fair results when left alone. Keep in the mind, the goal here is not to get a great result, but to at least get a decent result. Also, understand that I am not responsible for anyone’s losses, and I cannot make any promises as to future returns. Also, this article does not require a lot of novel insight or skill, it is pretty basic, and that is perfectly fine. Also, also, I forgot to mention that I put my portfolio from my first article into a paper portfolio so I can track the results, and write about them in the future, and will do the same here.

I would also like to preface:

1. Any money put into stocks, real estate, and bond funds(generally) you should not need in the foreseeable future. You should not put your down payment for a house in 3 years in the stock market. The reason why is diversified stocks, or even real estate can be unprofitable in the short to medium term, but over decades when left untouched will likely produce a worthwhile result.

2. As I stated before, the key for the defensive investor to do well, is to focus solely on 3 things. First save a lot and save every paycheck before you do anything else. Second, there is something called a turnover ratio. It measures how much of your portfolio you sell each year. If you turnover more than 10% a year on average as a defensive investor, you are doing something wrong. Third, you should put all the investments intended for retirement at the typical retirement age (which is probably most of your investments) into an IRA or Roth IRA.

An ETF is a collection of different investments put into one. It is an exchanged traded fund, and an incredibly popular version of it is called an index fund. When you buy an ETF, it is like you are getting a part of each sandwich and side inside a Culver’s versus just one burger. In the short run anything can happen to your ETF, but most funds when held for longer than ten years will do just fine and get you satisfactory results. I have thought and researched a solid amount on what a “defensive” portfolio should be, if it were truly to be the only investments you could ever buy and in the far future sell your whole life. I considered changing growth rates across the world, different outlooks for interest rates and inflation, and in the solid case that things go “reasonably” well over the next 50 years how would you best prepare.

Before explaining the ETF picks I will talk a little about asset classes. Businesses as I wrote about in my first article have transformed the world in the past couple hundred years. Over the past hundreds and hundreds of years, stocks have provided better returns than any other asset. More than real estate, gold, or bonds. This will likely be the case comparing returns over the next investing lifetime. However, I think there is what Howard Marks calls a sea change that will take place in the markets. As of writing the U.S stock market makes up about 50% of the global stock market. This is likely to shrink as the U.S only makes up 25% of world GDP. In addition, it is well known that as most things like economies get bigger and bigger it gets more difficult to achieve marginal gains. It will be far more likely for Indonesia(or another emerging economy) to achieve a 10X improvement in living standards or real GDP per capita before the U.S does. However, America is fantastic at releasing innovation and excellence. The main point though is that stocks are likely to continue to be the best assets to own over an investing lifetime as the world gets better and better over long periods. Also, the other half of the main point is that it will be quite important for a defensive investor to own international stocks.

The next best asset class when examined over hundreds and hundreds of years is real estate. Real estate comes in as a close second to stocks, and is a very good hedge against inflation. It also helps to produce income. It will be useful to know for the beginning investor that there are two main types of diversification. The first is owning different investments within an asset class. So instead of owning one stock, you own ten. The second type is owning different asset classes. So, you don’t just own stocks, but you own a house as well. This is useful. The biggest enemy of the investor is impulsive decisions. Full stop. Also not saving, and complete ignorance. I won’t lie though, I have seen quite ignorant people do well investing, because they at least held onto things for a long time and saved a lot. Howard Marks wrote a great book called The Most Important Thing. In the book he says there are like 15 most important things in investing. That’s because there are, which also doesn’t make sense and is very funny to me. One thing that brings out impulses in our investing is fear and panic. When you own 100% stocks you might end up statistically with the highest returns over 50 years. But if you weren’t able to hold and instead sold in a big crash, you could have screwed up years of work. But if you held 60% stocks, 40% bonds (a combo as classic as a big mac 2 piece from Mcdonald) your portfolio might have dropped by 15% less, and you might have felt well if at least all my stocks go to zero, I still have my bonds(which you wouldn’t if the market went to zero your bonds would be wrecked too, but we’re emotional creatures). So, there is a type of invisible returns we get by diversifying across asset classes even if it lowers the actual result a bit. Real estate provides this, as well as a satisfactory return, and is an elite hedge against inflation as evidenced by historical examples. Gold is a good hedge against inflation and panic, but over the ultra-long run has pathetic returns. In the past 75 years, Gold has been fantastic for gold’s standard, it has provided mid-single digit returns. However, in the ultra-long run of thousands of years it has only provided low single digit returns. It’s a good inflation hedge, but unlike real estate does not do as well in more normal times. I won’t consider bitcoin for “asset” diversification because it is more speculative than real estate. I have just absolutely no idea if bitcoin will exist or where it will be in 50 years from now.

Bonds when examined over hundreds and hundreds of years are the 3rd best asset class better than gold. However, bonds overall are pretty sucky. If you buy a group of investment grade bonds at let’s say 4.5% rates and inflation goes up into 4% on average the next 50 years, you barely increased your purchasing power. One thing I will say about gold versus bonds as the third choice. I think there is real validity in examining the returns of asset classes over ultra long periods to get a guide for the future, but not without using some common sense as you saw with the sea change in stocks. Gold is a good hedge against hyperinflation, and there has not been money printing over the ultra-long run picture of gold’s returns as there is now. So, maybe gold will do better over one’s investing lifetime than bonds, but given that real estate acts as an inflation hedge, I think having some bonds which act as a deflation hedge is useful. However, a lifetime of bond investing should actually not be as sensitive to inflation as one might first think. If inflation rises dramatically for any reason(cough cough tariffs) interest rates will rise with it, if this happens next year, and stays this way for a while, the investor buying a group of bonds will receive interest rates that probably provide for the inflation as interest rates usually go up with inflation. Now if a major inflation uptick happens after investing in a group of bonds for 30 years and stays for some time, and you have 50,000 dollars of cost/dollars you put into it, that will be bad. Your etf will be selling at a loss relative to what you paid, and if it has an average bond duration of 10 years your etfs interest rate, will take time to adjust upwards, so your capital will be getting eroded. The point is, investment grade bonds if things go well will give you maybe low to mid-single digit returns after inflation. If things go poorly they will lose you money after decades of investing. As Peter Lynch pointed out over and over again in his book Beat the Street, buy stocks not bonds. The only scenario where bonds will be really helpful in terms of returns is this. If a major slowdown in the growth of the global economy happens for a long time and perhaps there is inflation of only 1.5%, then stocks will not do as well, in this case bonds receiving an incredibly hypothetical 4.0% interest rate will be doing quite well versus a mediocre performing stock market. In the large majority of outcomes, over one’s investing lifetime, it will have been wise to have weighted stocks the most heavily, real estate the second most, and then bonds or gold or whatever the third most. I think bonds in a portfolio help to provide a small amount of diversification because of the asset class should provide some ok returns over long periods, and most importantly will help the investor to feel more at peace regardless of what’s going on in the world.

So given the data on stocks, real estate, and bonds that is what is forming the 1st portfolio, and the desire to do well with lower amounts of volatility rather than fantastic, whatever the future may hold. You say, why did I say the 1st portfolio? BECAUSE I AM GOING TO GIVE A SECOND ONE. 2 FOR 1 DEAL! If I was you reading this, I would subscribe for free (triple deal) just because of that, but that’s just my unbiased opinion. I am now writing this in addition about a week after originally creating it because I do think that a 100% stock portfolio is likely to do better over an investing lifetime. I also think it is a little simpler. It will come with more intense drawdowns, but I would hope the defensive investor would be mentally prepared to understand it as an opportunity to buy stocks cheaper, and that riding out the storm is the way to go. I am providing 2, one for the beginner investor who might have a little less tolerance for temporary losses, and one for the beginner investor who is confident in their tolerance and is somewhat understanding of market history and the likelihood that the market will recover. I would also like to mention that in the unlikely situation someone with a significant amount of money reads this, identifies as a beginner, and decides to implement one of these portfolio’s, it would be a good idea to space out the purchases over a two year’s span. If an investor had less than 3 to 5 thousand dollars, I think getting started is more important. Investors attempting a “passive” portfolio should learn the basic meaning of rebalancing, and dollar cost averaging.

Portfolio 1:

1. VT 25% Portfolio Weighting

VT is a basket holding stocks across the whole world, it is highly diversified and holds about 10,000 stocks. Currently about 60% of the weighting are U.S stocks, and 40% international. It has provided about 9% annual returns over the past decade and has a good chance of doing similar over a long period of time.

2. VNQ 25% Portfolio Weighting

VNQ is a basket holding U.S REITS, which are Real Estate Investment Trusts. They own and lease or rent out real estate of various kinds, shapes, and sizes. Overall, a big basket of REITS has historically performed a bit better than real estate on average. It should hopefully produce 7% or a bit more annual returns over the long run.

3. VXUS 20% Portfolio Weighting

VXUS is a fund holding stocks, but specifically only non-US stocks. It is very diversified and has provided about 5% annual returns since inception, but it will likely provide more like 7% in the future because that is closer to more long run international returns, and the returns for the international market have been low since the Great Financial Crisis.

4. VIOO 20% Portfolio Weighting

VIOO is a basket of 600 of America’s profitable “small” stocks. One lack of both VXUS and VT is that they are very top heavy, meaning they tend to allocate a lot more of the fund to the very largest companies, and not invest as much in the smaller stocks. By adding VIOO you both get an added diversification benefit, and you invest in small cap stocks, which have over long periods done quite well, and if history is a guide should provide 10%ish annual returns in the long run.

5. BND 10% Portfolio Weighting

BND is a fund holding a massive number of different bonds across every subsection of the bond market. Overall, the composition is investment grade bonds with a medium duration. If history is any guide, it should provide around 3.5-5% returns over the long term from its interest payments.

Overall an educated guess would be this portfolio nominally returns around 6-8% in the very long run, but as I have stated before I am not responsible for your financial results, and cannot Promise any outcome.

Portfolio 2

1. VTHR 30%

VTHR is a market cap weighted fund holding the 3,000 largest publicly traded U.S stocks. I like it because you get almost the whole U.S market, although it is heavily weighted towards the top, your returns will be very close to the U.S market as a whole.

2. VIOO 20%

VIOO owns 600 profitable U.S small caps which helps to ensure your U.S returns match the broader market, and small caps over long periods usually do better than large caps.

3. VXUS 30%

I like VXUS because you do not have to worry about country or strategy specific results, your returns should be pretty close to the international market as a whole.

4. VSS 20%

VSS owns 5000 international stocks that are small and mid caps. VXUS does not cover small caps very well, so by adding a piece of VSS in you help to ensure your portfolio’s returns capture the international market well.

Overall an educated guess would be this portfolio nominally returns around 7-9% in the very long run, but as I have stated before I am not responsible for your financial results, and cannot Promise any outcome.

Margin of Wisdom