The Simplicity Portfolio

Financial freedomInvesting can be made simple enough for anyone to manage their own investments. Here’s how.

For people that want to keep things simple, here’s an example portfolio based on low cost Exchange Traded Funds (ETFs) from Vanguard. This has been designed with people investing for the long term (eg financial independence) in mind.

Why Vanguard? Because it is owned by its customers. Vanguard are the only fund management group I know who have no incentive to over-charge you.

If you’ve been reading this blog and paying attention you will know that alignment of interests is one of the fundamental Principles of Lifehacking. Never entrust your money to someone who has the incentive and the opportunity to screw you.

Why ETFs? Because they are simple and offer the lowest ongoing fees. The ETFs are traded on the London Stock Exchange* and can be bought as easily as a regular share.  The ETFs used are:

VHYL = Vanguard All-World High Dividend Yield ETF

VEUR = Vanguard FTSE Developed Europe ETF (includes UK)

VUSA = Vanguard S&P 500 ETF

VFEM = Vanguard FTSE Emerging Markets ETF

One issue with index investing is that if the index is over-priced at the time of purchase, then the long term investor is doomed to poor performance. The challenge is trying to figure out whether an index is underpriced or overpriced when you come to invest. This is not easy, but fortunately all you really need do is avoid buying extreme cases of overpricing, which are relatively rare.

Sometimes it’s obvious that a market is in bubble territory. In response, we can reduce its weighting or avoid altogether.

So for example in 1989 I was a student and I knew almost nothing. But I knew at a price : earnings multiple of over 80x, the Japanese equity market looked insanely overpriced against the USA or UK. And when the US market peaked in 2000 at a CAPE of 44x amidst the dot-com boom and millennial celebrations, it was not difficult to realise that buying the index at that point might be dangerous.

I claim no ability to predict the future. When it comes to market timing, there are 2 types of people: those that don’t know how to do it and those that don’t know that they don’t know how to do it. So this is not an argument for market timing, it is simply an argument for having regard to valuations when investing. An over-priced market can keep going up in the short term, of course, but eventually a straw breaks the camel’s back and the process goes into reverse.

Looking for value is fundamental to all rational investing, even passive investing. The Simplicity Portfolio addresses this by seeking to overweight better value indexes and underweight over-priced indexes.  This differs from the approach advocated by many passive purists who recommend market cap weightings.

Here are the allocations in The Simplicity Portfolio:

The Simplicity Portfolio currently underweights the USA on the basis that the CAPE on the S&P 500 is currently approximately 26x, against a long run average of about 16x. So only 10% is allocated to the USA instead of a purely passive weighting based on market capitalisations of over 50%.

For the same reason (valuation), there is no allocation to small cap equities because small cap valuations don’t appear to offer additional value at this time.

With US valuations relatively high, particularly for many companies without long operating histories and track records of dividend payment (think Twitter, Facebook etc), I think its appropriate to tilt towards value as well as getting global exposure via VHYL which excludes non-dividend paying stocks. I also think its appropriate to have allocations to Europe (including the UK) and Emerging Markets, both of which trade on lower CAPEs than the US market.

The 75% equity exposure equates to the highest level recommended by Ben Graham in The Intelligent Investor which Warren Buffett describes as the best book on investing ever written. With interest rates at historic lows, bond yields are very low and the opportunity cost of holding bonds or cash is high. So The Simplicity Portfolio currently maximises equity exposure subject to the 75% constraint proposed by Graham.

Yes there are lots of scared people out there who will tell you that 75% equity is too high given that the markets look toppy and are just about to crash etc etc. But I don’t think it’s helpful to encourage the irrational fear that many people have of equity volatility. As Warren Buffett reminds us, the long term investor has more to fear from inflation than from equity volatility.

Unless we go down the property landlord route, most of us are going to have to accept equity-style volatility if we want to get to financial independence. Remember that price volatility is not the same thing as real risk. The best thing that investors can do is learn to understand and master their fear of volatility.

Equally, many people will say having 25% in cash / short term gilts represents an unacceptable drag on performance with yields so low. I have some sympathy with this but its no bad thing to have some “dry powder” to invest into equities after a crash. It would of course be possible to re-allocate some of this 25% towards other fixed income alternatives such as REITs, infrastructure funds etc.  If you are in the wealth-building phase and can ignore equity volatility, then feel free to take your equity allocation up towards 100%.

The portfolio is based on the principle of keeping things simple and costs low.  Note the expense ratio of just 0.15% per year.

This compares to typical total fees of 2.0% – 2.5% per year typical for customers of a financial adviser / wealth manager with active funds. These people are giving away most of their portfolio income to their advisers and fund managers for nothing.  Personally, I don’t see the point in having money if you are going to allow the income it generates to be taken from you and your children by economic parasites.

stealing candyThe reason that you rarely see simple solutions in investing advice is that 1) the customers are naive and 2) the financial services industry doesn’t make as much money from simple solutions. Its easier to steal candy from the kids when there is lots of noise and lots of toys in the sandpit.

As I showed here, minimising fees is incredibly important due to the effects of compounding. Many people can easily save a million pounds over the course of a lifetime by reducing fund management fees. If you have an easier way to make or save an extra million pounds, then I’m all ears.

turkeyThe income from the portfolio will obviously fluctuate based on the underlying economic performance of the assets and currency movements. I dont believe in trying to suppress volatility. Reaching for yield and paying up for “certainty” are 2 of the most dangerous and expensive things that you can do when investing. Remember The Turkey Distribution. Better to build flexibility and resilience into your spending.

The Simplicity Portfolio excludes gold and other commodities which can provide a store of value because, for those seeking financial independence its important to focus on wealth generating assets that pay an income and compound in value over the long term.

In the complex world in which we live, asset allocation and portfolio construction decisions are as much art as science.  There is no point in aiming for perfection: it is better to be roughly right rather than precisely wrong. What do I mean by roughly right? I mean that there is not a higher return (for equivalent risk) guaranteed elsewhere nor materially lower costs.

This is a low turnover, passive portfolio but all portfolios may need some change from year to year to rebalance and reallocate away from overpriced markets and towards better value alternatives. Low churn is good but complete neglect may not be. So its worth reassessing your asset allocation at least once a year and rebalancing if appropriate.

This is provided for information and is not regulated investment advice. This is a model portfolio and has not been tailored for any individual, including me. My portfolio is different, not least because it contains a large slice of actively selected quality equities. So think about your risk tolerance and asset allocation preferences when constructing your own portfolio.

But let me leave you with this thought. I’ve seen a lot of investors portfolios over the years (including many with the “benefit” of a wealth manager or financial adviser) and most of them are a mess. Most are full of historical baggage, pointless complexity and incur ridiculous fees for no good reason. The Simplicity Portfolio is simpler, lower cost and easier to run (without sacrificing expected returns) than 99% of what’s out there.

Welcome to the 1%.

*and the SIX Swiss Exchange and NYSE Euronext Amsterdam

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  1. dawnmartyne · · Reply

    Excellent post. youve addressed all my constant internal churning arguments.
    logical . sensible .my portfolio is similar but not the same.
    no Japan though, unless exposure is in VHYL
    i read once no more than 75% in equities and no less than 25%. this suits my risk tolerance.
    i thought about the landlord route but have been put off .
    as thats the case with me then i agree with you, you just have to get used to and tolerate equity volitility.

  2. Instant diversification and extremely low cost…what more do you/we/they need?!

  3. Very interesting thoughts in this article. It comes at the right time. As my goal is to have a mix of dividend stocks and an index portfolio, I wonder when and how to build up the dividend portfolio.
    an answer might be right here: buy dividend stocks if there is a general over valuation of the etfs you have… It gets me thinking…

  4. I retired a while back (Similar to yourself) and this is very close to my portfolio – I have 5 funds over your 4. I added a specific Pacific/Asia a year or so back (Looked good value at the time). Overall, whilst not producing “stunning” returns, the dividend income delivers 1.5x my outgoings and the volatility is way within my comfort zone. Sat on about 23% Bonds at the moment, but if the equity market crashed (say 20%+ further) I would dump the majority of these and go 99% equity. To be honest, I’m secretly hoping that it happens as I would love to buy something that seems really cheap again.

  5. Derrick · · Reply

    Great post. Thank you. One question:
    Isn’t the essence of ‘VUSA Vanguard S&P 500’ contained within ‘VHYL Vanguard All-World High Dividend Yield’?

    1. Not really…the US is only about 36% of VHYL. And the dividend yield screen means the US element of VHYL is not the same as the S&P500.

  6. Rookie question: why these ETF’s instead of something like Vanguards Lifestrategy 80% equity fund….

    Is it down to the even lower charges you can obtain this way, or do you consider you will see better returns on the ETF’s.

    I am currently building up a fair bit (for me) of ISA holdings in the Lifestrategy 80% fund, so genuinely interested in learning opinions on this.

    1. dawnmartyne · · Reply

      i think i can answer your question
      lifestratergy funds asset allocations are pre set and theres a huge US proportion in there, i think its about 60 % US and quite a small emerging market allocation.
      TEA is trying to ’tilt’ away from these pre set allocations by using these 4 individual ETF ,s so he can underweight the US which is possibly too expensive at present to justify 60% of your money
      and overweight Europe and the UK which is generally considered a cheaper market at the moment.
      emerging markets are possibly where alot of future growth may come from. so hes upped VFEM
      hope that answers your question.

      I have a question for TEA
      Why is VHYL considered a ‘value’ fund?

      1. LCIL – I’m looking for better expected returns by tilting towards value (as Dawn rightly says) as well as slightly lower costs.

        Dawn – high dividend yield is a screen for value….there are others of course (low PE multiple, low price : book or price : sales etc)…but high dividend yield is probably the simplest…and its the one that Vanguard offers.

      2. LS80 has three components involving US equity:

        19.5% US equity index fund, 3% S&P500 etf, & 19.2% dev world ex-UK fund (of which 60% is US).

        Overall, the US equity component of LS80 is about 34.02%

  7. What do you think about robo-advisers like Betterment and Wealthfront? Is it even good for new investors or should the naive investor start with Vanguard?

    1. Personally, I don’t see the need as using them increases your expenses and The Simplicity Portolio is simple enough to easily rebalance yourself. I don’t think Betterment operate in the UK either. But MMM seems to like them so maybe worth checking out his articles?

  8. I see basic flaws in this asset allocation, if its to survive a 2008/09 scenario. You are not in the accumulation phase anymore, I would bump up the bond allocation, even at current bond valuations, use a broad bond market ETF, low TER, do it in 10k blocks over a period, and add long maturity bonds as a hedge against equity market drops. Also, if you needed to realise income from this, you would be shafted if indexes went down double digit % and kept dropping. Its obvious to a lot of professional investors that valuations are stretched in equity markets. Better to go for dividend ETFs for all the equity portion, IUKD, European and Global. Also, you need corporate bond exposure, good for more income. Hands up, I am a hedge fund manager. I just wanted to add my 2 pence. NG.

    1. …if you are a hedge fund manager then you might want to read this and this

  9. I’ve seen this mentioned a lot and I am quite impressed with it. Currently advising Miss DD to consider adopting it for her investing activity. Whether or not she is persuaded is a different matter.

    Thanks for the fascinating write-up. Very interesting.

    1. TDD, glad you found it helpful. Thanks for the comment and the feedback.

  10. I agree, simplicity is important when selecting your investments, and there really is a lot of overly-complex but under-performing crap out there with ridiculously high fees.

    Diversification is fine, but do you really gain anything more by having 400 stocks in your portfolio than by having 40 stocks? Many fund managers seem to think so, but it doesn’t show up in their returns and just creates more work that someone needs to be paid for.

    It’s direct shares/stocks all the way for me, but I agree that ETFs/managed funds/mutual, funds have their place for some investors.

  11. therhino · · Reply

    great article – thats a very nice looking portfolio

    you hint at a mechanical allocation based on index PE ratio – maybe you could include the PE numbers relevant to each of the indices in your mix, i.e. the current value compared to long term average (as you have done for the S&P500)

    also – are all those ETFs income only as opposed to accumulation units?

    1. Yes, they all pay out income

  12. Great post – a simplicity portfolio is a great idea. I have moved quite a few funds across to Vanguard equivalents to reduce costs. I would like to invest in the High Dividend Yield fund but this isn’t offered by my investment platform. I am looking to move platform, looking at the platform charges so that I can move to someone who does offer the full Vanguard suite and has a low-cost charging structure.

  13. This is pretty close to what I was trying to put together for myself.

    I am going for 100% equities for this porfolio:
    VHYL – value 30%
    VEUR – europe 30%
    VFEM – emerging 15%
    VMID — FTSE midcap 10%
    VUSA – USA 10%

    And plan on rebalancing annually. If only the S and P had a correction I would just pump 100% into an all world tracker. From visiting american forums they are definitely extremely bullish on US shares which is a warning sign to me.

  14. Any feedback would be much appreciated before I pull the trigger in the next month

    1. dawnmartyne · · Reply

      that looks a good selection to me
      i agree , i wish the S and P would have a correction it would make things alot simpler and easier

  15. Why have You missed the FTSE Developed Asia Pacific ex Japan Index UCITS ETF (VAPX)? It is cheap: dividend (3,2%); P/B (1,4); P/E (14,2).

    1. for simplicity…the fewer ETFs you buy, the lower your transaction costs.

  16. Thoroughly enjoy the website and as someone sitting on a pile of cash this post and the recent one on fear were particularity interesting. Wondered if you had any thoughts on investment trusts as part of a simple portfolio, especially with regards to the generation of income? I am torn at the moment between something like the portfolio you post above and an investment trust portfolio as put forward in John Baron’s website. Any thoughts could be illuminating.

    1. TJ – Investors in investment trusts suffer much higher fund management fees…so will underperform in aggregate over the long term. With investing fees, you get what you don’t pay for.

      If you are sat on a pile of cash, read this.

  17. The Weasel · · Reply

    Hey TEA, my portfolio looks very similar to the one you’ve put together here. I wonder if you know of any substitute for VIGSCA. (This is where I differ from your portfolio) I’m in this fund as I wanted some exposure to small caps given my long term horizon. But I don’t like the relatively high fees (0.38). At the time I couldn’t find any alternatives with my broker AJ Bell, but maybe you can give me some clues.

    Thanks for sharing this stuff with us newbies!

  18. Nice. I didn’t know Vanguard did a high yield ETF, will check it out!
    Hoping for another mini crash soon so can pick it up even cheaper after next payday 🙂

  19. This is a great article and I enjoyed the comments. I am now looking to add some ETFs and maybe switch some of my other unit trusts and investment trusts ( i have about 8 across a balance of areas) when I feel the time is right. I try not to tinker so mainly have an invest in value funds and leave strategy. I realised I didn’t have enough money in bonds so have been so have been investing quarterly into Vanguard Life Strategy 20% as I am 62, but I should have a good enough Army, Teaching, Private and State pensions to be able to keep investing in retirement when I am 65. I also have no mortgage and a letting property with no mortgage, mainly because i have always been a saver throughout my life. Your articles are very helpful because they make me do some deep thinking on the best strategies to suit my needs. I definitely like the idea of lowering investing charges and costs so Vanguard are very attractive.

    1. Glad you found it helpful, Howard.

  20. darkwhizz · · Reply

    What do you think of the SPDR S&P Global Dividend Aristocrats ETF as an alternative to the Vanguard All-World High Dividend Yield ETF? The index it tracks seems to have a different methodology as it has a very different list of companies on its list. (I can’t work out what’s the difference in method) The TER is at 0.45%, slightly higher compared to Vanguard’s 0.29%.

  21. I enjoyed your article, thank you. I hope someone can help. In this instance, Google as not helped but confused things further for me. I have been paying a small amount on a monthly basis into these two index funds:

    Vanguard FTSE DvpWldExUK EqIdx A
    L&G Global Emerging Mkts Idx I Acc

    My question is: are ETFs better in longer term compared to the funds above? My understanding is that the main different between an index fund and an ETF is that ETFs are priced throughout the day like a stock, whereas an index fund is priced once a day. I cannot see how this would make a different to a small investor like me who squirrels away a bit of money once a month over the longterm. My current platform, Axa Self Invest does not seem to offer ETFs. I would rather make the change now whilst I do not have a lot invested.

  22. Fulla · · Reply

    I’m approaching 70 y,going to retire end of this year, living in one of the golf country, having few hundreds thousand £ in the bank , zero interest , what would you advise me to use this money please?

    1. dawnmartyne · · Reply

      It depends if you want to leave any money to anyone once your gone. If it was me Id hang on to most of the cash and enjoy spending it over the next 10 plus years . Id certainly put ‘an amount ‘ in the markets, id use the simpliciy porfolio suggestion as my allocation. The problem is if you put a fair whack in now and the markets fall it can take 10 years to break even again and youd be 80 ish then . Cash is safe at 1% theres no growth but do you need to take the risk putting it in equities?

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