A Two-Fund Portfolio?

published 26 January 2010

Charles Ellis is a living legend in the investment world. In 1972, he founded Greenwich Associates, one of the most famous global pension and institutional investment advisory businesses, which he ran until 2000.

He’s the author of 15 books, including Winning the Loser’s Game, an elegantly written investment classic that distills timeless wisdom about drawing up a long-term investment policy, how to understand risk, the importance of time in investing and how to construct an efficient portfolio. More than half a million copies of the book have been sold, and it was published in the fifth edition last year.

Now 72, Ellis still advises wealthy families and large institutional investors on how to invest. We asked Ellis, who has taught at Harvard’s and Yale’s business schools, to recommend a retirement portfolio for the individual investor. His response: Put it all in Vanguard Total World Stock (symbol VTWSX) and Vanguard Total Bond Market (VBMFX). For his suggested allocations by age, see below (Ellis, an ardent proponent of indexing, was also a director of Vanguard).

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A portfolio with only two funds? Ellis has an intriguing rationale.

The simplicity of his advice brings to mind a maxim of Albert Einstein’s that Ellis is fond of citing: “Everything should be made as simple as possible -- but no simpler.” For more distilled wisdom on investing and other aspects of personal finance, read The Elements of Investing (John Wiley & Sons, $19.95), which Ellis coauthored with Princeton professor Burton Malkiel, he of A Random Walk Down Wall Street fame. This classic primer provides basic tips, such as establishing investment goals and tailoring your holdings to your tax bracket. You can breeze through the concise volume in two hours. (Malkiel is a former Vanguard director.)

You’ll notice that Ellis’s portfolios are heavily weighted toward stocks. He worries that investors whose portfolios are tilted more toward bonds will come up short of cash in retirement. “The risk of running out of money before you die is larger than you think,” he says. “Most people are underprepared for living as long as they will.”

Nor is Ellis likely to change his view of bonds. In fact, he thinks most investors should be reducing their allocations to bonds. “I have a real reservation about buying bonds now because interest rates are low and the total return to investors in the future doesn’t look attractive to me.”

Ellis himself says he still keeps 100% of his personal retirement portfolio in stock-index funds, and has throughout his career (he holds both U.S. and foreign index funds because his investment program began before the creation of Vanguard Total World Stock). His explanation is that because he’s accumulated sufficient wealth, he’s really running the portfolio now for his wife (who is younger than he is), children and grandchildren.

Note that if you were to purchase Total World, you would be putting more of your money into foreign stocks. The fund’s current allocation is 59% in foreign stocks and 41% in U.S. stocks.

Ellis says that diversifying by nation, market, economy and currency brings tremendous benefits to a portfolio. He’s bullish on potential growth in emerging markets, where, he says, “1.5 billion people have been lifted out of poverty over 30 years.”

Returns from U.S. stocks are unlikely to be as generous as they have been over the long haul, says Ellis. U.S. stocks returned 9.8% annualized from 1926 through 2009, according to Morningstar’s Ibbotson unit. Ellis says to expect closer to 8% annualized in the future. “If I’m wrong,” he says, “it will be less than 8%, not more.” For one thing, he notes, the current dividend yield of 2% is scarcely half the historic average (historically, more than one-third of returns from stocks have come from reinvested dividends). And price-earnings ratios have crept up over the decades.

Finally, Ellis reminds investors to rebalance their portfolios periodically to restore the desired allocations. And don’t get too fancy with your portfolio, he cautions. “A little bit of personal modesty is in order.”