Investing can be complicated and sometimes you just want to simplify your investing in a way that still gets you a good return while protecting you at the same time. The Idiot Proof Portfolio is a simple low-cost, low maintenance, easy to understand approach to investing. What you eventually decide to do is up to you, but sometimes keeping things simple is the best route for long-term investing success.
The fact is most people don’t need a complicated investment strategy. They either don’t have the capital, the know how, or time to make it worth while and they never will. Yet we continue to take on unnecessary investments because someone, somewhere stated that is how it’s done. The arguments usually contain terms like diversification, risk aversion, and cost control all things you’ll get with the Idiot Proof Portfolio.
What the Idiot Proof Portfolio provides is an easier way to understand, manage and invest your money. It’s not sexy or exciting. But it leads to low costs, simplified taxes, less paperwork, easier rebalancing, and just spending less time hassling over your investments. It won’t break any records but it will protect you in down markets and reward you in up markets, as long as you stick to it. Most importantly you’ll know why.
The Idiot Proof Portfolio
The portfolio has a goal of easy maintenance, low-cost, risk control and diversification. It has two, yes two ETFs. That’s it, there is no complications having to distinguish between small cap or large cap, value, growth or income, international or emerging markets. All it requires is long-term consistency.
- S&P 500 Index ETF – If you can’t find an S&P 500 fund you shouldn’t be investing in the market. Every quality fund family has one and it’s one of the lowest cost ETFs out there. An invest in an S&P 500 fund is an investment in the overall market.
- Intermediate Term Government Bond ETF – This is the safety investment and will be used to offset the risk of the stock market. It invests primarily in U.S. government bonds which carry less risk and are a safety vehicle when times get tough.
Age in Bonds
The basic rule of thumb for any portfolio allocation is to have your age as the percent of your money in bonds. It’s pretty simple really. If you are 35 years old, you should have 35% in bonds, leaving 65% for stocks. If you are 75 years old, you should have 75% in bonds and 25% in stocks. The reason is just as simple. As you get older the amount of risk you take should decrease.
Bonds tend to be less risky than stocks, especially a Government Bond ETF. But it’s not always the case. When you’re ready to take more control of your asset allocation, you can adjust your stock and bond weighting based on economic conditions and interest rate risk. But for now, just focus on this age rule.
There’s Diversify And Then There’s DIVERSIFY
One of the biggest arguments for owning multiple funds is the spreading of risk through the diversification of your money. But it’s not always true. You can easily spread that money so thin that you limit your investment potential. More funds does not mean better diversification. It just increases your chances of overlapping your investments.
If you think about a fund like an S&P 500 Index ETF, it holds about 500 stocks covering all the types, sectors, and market caps. It mimics the S&P 500, the index every fund is compared. If that’s not diversified enough for you, there is the Intermediate Term Government Bond ETF which does the same thing on the bond side. These two funds offer more than enough diversification for anyone.
I’m sure some may argue that the Idiot Proof Portfolio is lacking in emerging market or international investments. I would disagree. There are enough stocks in the S&P 500 ETF with exposure to those and other markets.
Use Stocks For Your Risk Asset
In every investment portfolio there are more risky and less risky investments. When you are dealing with a simplified portfolio that already limits the number of assets you invest in, look for risks in stocks and safety in bonds. It’s that simple. This way the “age in bonds” rule of thumb will manage your risks for you over time. The less risky Government Bond ETF will protect you on the downside and lower your overall portfolio risk.
Low, Low, Costs
The Idiot Proof Portfolio relies on low-cost investing, keeping more money in your account. ETFs are some of the lowest cost funds. This keeps your cost of investing low.
Many discount brokers offer free ETF trades for the more popular types of ETFs, like an S&P 500 ETF and Government Bond ETF. I use TD Ameritrade because of it’s big selection of the commission free ETFs. The low cost help when you add new money, rebalance your portfolio, or start withdrawing money when you hit retirement.
If you are new to investing or just want to simplify a complicated strategy, the Idiot Proof Portfolio is a good starting point. As your knowledge and wealth grows, you can easily expand on the portfolio as you see fit. Until then, keep your portfolio long-term and simple.
Image: Flickr – CJ Sorg