The CoffeeHouse Portfolio
This is another in my series of reviews on popular fixed asset allocation portfolios. Bill Schultheis is well known to many of you as the author of The Coffee House Investor, perhaps the most readable text out there on investing. He also has an investing firm and a website. Bill would be the first to admit that there is no single “coffeehouse portfolio” but many investors have misunderstood his message and implemented the suggested portfolio anyway. It isn't a bad portfolio, and because of its popularity, it's worth a quick review here. Here it is:
10% Large Cap Stocks
10% Small Cap Stocks
10% Large Value Stocks
10% Small Value Stocks
10% Total International Stocks
This is basically a “slice and dice” type portfolio rather than a “total market” type portfolio. An example of a total market portfolio would be 1/3 Total Stock Market Index (US), 1/3 Total International Stock Market Index (International) and 1/3 Total Bond Market Index. A slice and dice portfolio tries to take advantage of the higher expected returns (probably due to higher risk) of both small stocks and value stocks. You can see that this portfolio has a heavy concentration of both small, and value stocks. For example, compare the 40% of the portfolio in US stocks to the overall US stock market.
Using Morningstar's Portfolio X-ray Tool, we can see that the overall US market has just 3% in small value stocks. By comparison, the Coffeehouse Portfolio has 17% in small value stocks, five times the amount. That's a pretty significant “tilt” to small value, which is really a bet that Fama and French were right that small value stocks should have a higher long-term expected return than the overall market. Now I tilt my portfolio to small value but not as much as the Coffeehouse Portfolio does. Doing so comes with its own risks, including the risk of tracking error, but the long-term track record is fairly compelling.
The portfolio has a relatively heft REIT tilt as well. I also buy into the fact that REITs are a separate asset class, and hold a “slice” of them in my portfolio. However, the thinking 10 years ago or so when this portfolio was developed was that REITs have a lower expected return and lower expected risk than stocks as a whole. The last decade has really turned that thinking on its head, especially the 75% dive that REITs took in 2008. Like gold, I'd be cautious having too large of a slice in this in your portfolio. 1/6th of the stock portion of the portfolio seems a bit much to me. My own portfolio holds 1/10th.
Much criticism has been leveled at the portfolio's relatively low percentage of international stocks. Keep in mind that when the portfolio was developed, few US investors were doing much international investing, especially after the huge run-up US large cap stocks had in the late 90s. 1/6 of stocks being international stocks was considered a pretty good amount then. Even 5 years ago my own portfolio with 1/3 of stocks being international was considered to have a lot of international diversification. Nowadays, it isn't uncommon to see people with 50-60% of their portfolio outside the US. It's a difficult decision to make when developing your own asset allocation. In my opinion, reasonable amounts for a US investor to invest overseas range from 20-50% of your stocks so I see the CoffeeHouse allocation as being a little light.
I like the fact that he keeps the CoffeeHouse bond allocation relatively simple and straightforward, generally putting it into a broadly-indexed bond fund such as Total Bond Market or Intermediate Bond Index Fund. Asset class snobs like myself like to complicate things as much as possible just to have something to tinker with, but that really goes against what the CoffeeHouse philosophy is all about anyway, which is, in Thoreau's words, “Simplify, Simplify, Simplify.”
The overall 60/40 allocation is what many institutional and individual investors have been using for decades. I think it is a great place for any investor to start. A young person with a small portfolio and a large tolerance for risk might want a more aggressive portfolio, and a retiree may want a less aggressive one, but if I had to pick one allocation for everyone to follow, I think 60/40 would be it.
Returns over the last 20 years have ranged from a 20% loss in 2008 to several years of 23% gains. The overall portfolio returns from 1991 to 2010 is ~ 9% a year, which is pretty typical for these fixed asset allocation portfolios, and certainly enough to retire on. A poster named Madsinger on the Bogleheads forum posts monthly updates of the returns of various fixed asset allocation portfolios. He calculates out the annualized return of the CoffeeHouse portfolio from 1999 to present as 6.35%, which isn't bad at all considering that period of time encompasses two huge bear markets. It ranks near the top of all the portfolios he tracks and well ahead of the Vanguard S&P 500 Fund at 1.65%.
In short, there's nothing wrong with adapting the CoffeeHouse Portfolio and making it your own. Like with the Permanent Portfolio previously discussed, it's probably more important that you stick with your plan than the weighting of your particular allocations. Any reasonable asset allocation is okay, but it needs to be one you can hold through thick and thin. Better to be a little more conservative and conventional than you think you need to be, at least until you pass through a bear market or two.
Disclosure: I have no financial relationship with Mr. Schultheis although I do get a small commission if you buy his book from my link.