One of my favorite ways to review Servo’s planning and investment approach with people who are interested in becoming a client is to evaluate their existing portfolio within the context of their long-term goals and our philosophy about markets.  I almost always find that people — whether they are do-it-yourself investors or clients of another advisor or a broker — could be doing better in a number of different respects.  

I recently took a look at a taxable account managed by a Wall Street brokerage firm that was typical of what I see.  The individual was kind enough to allow me to report my findings in hopes that other people with similarly complex situations could see that there is a better way to plan and invest for the future.  If you are not a Servo client but would like a similar evaluation of your portfolio, don’t hesitate to contact me.


Q: What it the best way to design a long-term investment portfolio?  

In short, it should be: based on each person’s individual goalsutilize a transparent and easy to understand processbe diversified and cost effective while trying to capture the expected returns in the market.

Q: Is the asset allocation appropriate?  

The current portfolio is a mix of stocks, bonds, and “alternative” assets.  52% is in stocks, 37% in bonds, and 11% in alternatives.  Does the investor believe that it’s appropriate?  Not at all.  Nor do I.  Their goals are long-term growth with only modest needs for periodic ongoing income.  They are willing to accept a high degree of short-term volatility in pursuit of higher long-term goals.  The time horizon supports this–the portfolio could be in place for another 40 years.  Only 50% in stocks is far too conservative.  The bond allocation is way too high.  

There’s also no need for over 10% in “alternative” assets.  These are strategies that in theory are supposed to have good returns but also provide diversification to both stocks and bonds.  In reality, they are extremely expensive, they have had returns less than stocks and bonds, and have not provided the diversification they promised.  

The portfolio is also far too complex–28 stocks and another two dozen mutual funds may look sophisticated, but its not, it’s just complicated.

Finally, all the mutual funds are “actively managed,” an approach which has been shown to reliably underperform over time, especially net of higher taxes.

Q: What might I suggest as an alternative?  


I provided two alternative asset allocation examples — one with 80% in stocks and 20% in bonds, the other with 70% in stocks and 30% in bonds.  The profile was radically simplified — a few “Core Equity” funds own almost every publicly traded stock in the world with an increased emphasis on smaller, lower-priced value, and higher profitability shares (the very bottom of this article documents the historical payoffs to these different dimensions).  Two bond funds target investment grade corporate and government bonds in the short to intermediate-term window across a dozen different developed country bond markets.  You could explain the genesis of this portfolio in less than a minute.

Q: What’s the difference in costs?

Our market-based approach to investing isn’t just simpler than traditional investment strategies, it also typically has far less in fees.  In this case the proposed allocations were 4x cheaper than the existing mutual fund allocation and 3x cheaper than the total portfolio that included individual stocks.

Q: How does the US stock allocation compare?

The Dimensional US Core 2 Strategy sits south and west of the overall market index on this graphic, meaning it has a “tilt” to smaller and more value-oriented stocks and therefore higher expected returns.  The existing stocks and mutual funds (see “Current Total Allocation”) instead sit north and east of the market, indicating an overall allocation to large cap growth and lower-than-market expected returns.  Beyond higher costs and added complexity, the existing portfolio faces a headwind from poor allocation design.

Q: How does the international stock allocation compare?

Somewhat similar conclusions.  While the Dimensional International Core Equity Strategy sits south and west of the market, indicating a “tilt” to small and value stocks, the existing portfolio also is smaller than the market but has a growth tilt.  That’s like driving with your foot on the break (smaller is better, but the growth orientation reduces expected returns).

Q: What about emerging markets?

Again, same thing.  The Dimensional Emerging Markets Core Equity Strategy sits in the region of higher-expected returns, the existing portfolio is larger and more growth-oriented than the market and has lower expected returns.

Q: What kind of bonds do you own?

The role of bonds in a long-term, growth oriented portfolio is to dampen stock market volatility and provide a decent overall return without excessive risk.  Average maturities should be around five years or less, and credit quality should be relatively high — more AAA/AA bonds, less A/BBB bonds, and no “junk” (BB or less).  The existing portfolio holds far too much in longer-term (10 years or greater) bonds and extremely risky credit qualities (over 50% is in BBB or lower bonds).  The “hypothetical” allocation, a 50/50 mix of the Dimensional Investment Grade Fund and Dimensional Five-Year Global Fund, demonstrates a more prudent approach to investing in bonds with higher-expected returns than cash or a treasury-only bond or CD portfolio.

Q: What about the “alternative” assets?

I’ve already covered these briefly in comments above, but the table below lists them out individually including their expenses (2% to 3% a year, unbelievably high) and portfolio breakdowns (they are excessively ambiguous).  When you add in how tax inefficient these alternative funds are, it’s almost impossible to make a case to include them in a portfolio.  Fortunately the returns have been so bad in recent years they offer tremendous tax-loss-harvesting opportunities.

Q: Any thoughts on the individual stocks?

There’s really no reason to hold individual stocks today, except for entertainment purposes.  Broadly diversified ETF and mutual fund portfolios have much better risk-to-reward tradeoffs for serious long-term investors and make designing and managing a well-diversified portfolio much easier.  But this stock portfolio in particular is a no-go.  It’s almost exclusively invested in large cap growth stocks and is extremely concentrated in just a few names.

Q: There’s a lot of good research here, can you summarize it?

Sure — a successful investment approach has several characteristics. It is informed by your specific long-term goals.  It is based on a sensible and durable investment philosophy.  Its design is streamlined and efficient, while also being well diversified and cost/tax sensitive.  Finally, it is easy to understand and monitor.

In the example above, there is no evidence any of these principles have been adopted.  The asset allocation does not align with the investor’s goals, the portfolio is excessively complex,  costs too much, is too tax inefficient, and completely ignores opportunities to target well-documented sources of expected returns.


Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.