What Makes a 'Perfect Portfolio'? Thoughts From Bogle, Markowitz, Siegel, Others

But Bogle said that stocks and bonds will get you very far without having to worry about other asset classes.

From a risk-and-return perspective, his philosophy was that by limiting yourself to stocks and bonds, you’ll go a long way in terms of getting those benefits from the diversification that Markowitz talked about.

Bogle also contended that “investors make a big mistake by thinking too much of the value of the account and not enough about the monthly income [including Social Security] they want to get.” What’s your take on that?

Some investors are overly focused on the price they’re paying but lose sight of why they’re investing. If investing for retirement, what you really care about is the income that’s going to be derived. 

Bogle said also that in retirement, there isn’t a real need to rebalance major asset allocation classes. “Regular rebalancing isn’t terrible but not necessary” was his way of thinking. Comment?

Again, there are conflicting perspectives on the whole notion of rebalancing, and I think the verdict is out on that. 

If there’s more of a momentum trend in a long bull run in equities, say, then by not rebalancing, you’d be better off. 

Bogle’s [general] perspective was: Let it ride and perhaps not be as regimented about rebalancing according to a [specified time frame]. 

Jeremy Siegel, the Wharton finance professor who wrote “Stocks for the Long Run,” recommends that at least one-third of an equity portfolio should be invested in international stocks. What’s his rationale?

Research shows that [regardless of] the proportion of equities the country you live in might represent relative to the world portfolio, people tend to be overinvested in domestic equities — that’s known as home-country bias — regardless of where they live.

I think the U.S. might now be roughly in the 50% range in terms of the market cap of U.S. stocks as a proportion of world stocks.

Siegel is trying to nudge people away from this home-country bias to include at least a third of international equities.

He argued to “tilt the portfolio toward value stocks that have low P/E ratios or higher dividend yields.” What’s the advantage?

That goes back to the work of [University of Chicago professors] Eugene Fama and Kenneth French about price vs. value. [Fama won a Nobel Prize in economic sciences in 2013.] 

Fama and French found that value stocks tended — over the long run, decades — to outperform growth stocks. And small-cap stocks tended to outperform large-cap stocks.

So Siegel says don’t just chase growth stocks that have prices that have been going up quickly. They might not be paying out dividends. In the long run, you may be better off with a stock at a relatively lower price that has better prospects for dividend payments and therefore return.

In your book, Siegel says the ideal portfolio should have an equity holding of 50% in world index funds — 30% U.S.-based, 20% non-U.S.-based — and to allocate the remaining 50% to strategies that will enhance the return. Please elaborate on the latter. 

For example, be aware of emerging industries that may have enhanced growth opportunities at a particular point in time, like real estate investment trusts [REITs] or certain sectors, perhaps [pharma or consumer staples, for example].

Siegel is firm about avoiding “hot stocks” and IPOs. Why steer clear of IPOs?

The literature shows that the typical pattern is a bump in the IPO’s stock price on the first day — even to the tune of 10% to 15%.

However, after that one-day bump, over the next three to five years, IPOs typically tend to underperform the market, though, clearly, some stocks run counter to that, like Google.

Charley Ellis, the renowned investment strategy consultant, is author of the classic “Winning the Loser’s Game.” What does he say about constructing the perfect portfolio? 

In the 1970s, he saw that individual investors often tried to outperform but ended up shooting themselves in the foot. He was the first person well known inside the industry to advocate for passive investing even before the index fund was available as a retail product.

In aspiring for the perfect portfolio, he says, “Don’t invest in commodities, as prices can fluctuate wildly; and if you’re a long-term investor, don’t own domestic bonds in a low-interest-rate environment.”

So, his thinking is more along the lines of Bogle in terms of the narrower approach with asset classes and domestic bonds.

Ellis also emphasizes paying attention to taxes. He says: “Index funds typically turn over at 5% a year, and a well-managed index fund will match gains and losses so that there actually is no tax. 

“Actively managed mutual funds turn over at 40% a year, and the gains are taxable at ordinary income rates,” he points out. Obviously, he feels that index funds have big tax advantages; so always consider taxes, correct? 

Yes. He and a number of our luminaries as well stress attention paid to taxes.

If you have high turnover, which will create capital gains, then there could be tax implications versus the typical index fund, for example, which has a much lower turnover, and which could help you from a tax deferral perspective.

Part of Ellis’ philosophy is: “Don’t think of your house as an investment or treat it like a bank from which you can borrow.” How does that compare with the philosophy of the others you’ve profiled?

It’s a different perspective from Shiller, for example. Ellis’s perspective goes back to [ideas in] his book “Winning the Loser’s Game.”

I’ll use the financial crisis as an example: A lot of individuals were very highly leveraged in terms of mortgages on their homes. The lenders made the assumption that house prices always go up and that being highly leveraged didn’t matter because the price will go up. 

But clearly, we know that didn’t end well. Many people at the time were treating their homes as a financial investment, which they never [really] were. 

With all the research that Professor Lo and you conducted for the book, did you uncover anything surprising?

One of the endowment funds that Bogle oversaw didn’t only have passive index funds. He had a component with an investment in gold. That was a surprise! 

Why do you suppose he made the decision to buy gold?

He felt that it was a small hedge against some major catastrophe — a major risk — and that it might balance things out a bit.