Model Portfolio #7: Unconventional Success by David Swensen

This model portfolio is taken from Unconventional Success by David Swensen. As mentioned before, Swensen is not a personal financial advisor, but is a respected institutional money manager who currently runs the Yale Endowment. In his book for individual investors, he writes that there are only a limited number of core asset classes in which one should invest in. Although he avoids giving specific asset allocation guidance, he does provide an “outline of a well-diversified, equity-oriented portfolio”, which is shown below.

Unconventional Success Model Portfolio Breakdown (Hurrah, I found my software disks so I can make pretty pie charts again!)

Asset Allocation For 70% Stocks/30% Bonds (with ETF examples)
30% Domestic Equity (VTI, IYY)
15% Foreign Developed Equity (EFA, VEA)
5% Emerging Markets (VWO, EEM)
20% Real Estate (VNQ, ICF)
15% U.S. Treasury Bonds (SHY, IEF)
15% Inflation-Protected Securities (TIP)

Commentary
There is a healthy portion devoted to real estate in the portfolio. The common way to track this asset class with REITs, which are considered a domestic stock. Instead of taking up less than 5% of the US stock market by capitalization, it is now taking up more than 40% of the domestic equity portion. I’m not really sure why there is so much, although he does write that if you own your home or other real estate, you may want to reduce your REIT exposure.

In addition, corporate and mortgage-backed bonds are left out, following his opinion that they aren’t the most desirable asset classes for individual portfolios due to added call risk and credit risk. (If you’ve been keeping up with the markets recently, it seems he may have been on to something here.)

As with all the model portfolios, the idea here isn’t just to follow any of them blindly. I do think it helps to see where different experts have similar components to their model portfolios, and where they differ. I also like breaking it down this way into pie charts of stocks-only and bonds-only in order to visualize them better.

See here for other model portfolios from respected sources, part of my incomplete Rough Guide to Investing.

Comments

  1. Interesting. I’m glad to see that almost a third of his equity portfolio is in real estate. I’ve always kept track of my asset allocation (in pie charts in fact), and it’s been bothering how skewed the chart has become since I purchased a condo last year. My goal was to keep real estate at or below 35% of all my assets. I’m glad to know that at least one other (financial) person thinks that’s reasonable.

    By the way, I like your blog and put a link to it on mine. Keep up the good work!

  2. Not sure where the real estate is, only 29% according to the graph. That’s not 2/3

  3. 2/3rds of the entire *domestic equity* allocation

  4. oops yeah, it should be 1/3rds

  5. Actually, don’t you mean 2/5ths (i.e., 40%) and not 1/3rd?

  6. enonymous says:

    Would holding US Treasuries and TIPS (or their respective mutual fund or ETF counterparts) in a taxable account be considered a mistake? It seems that given the interest these spin off (and correct me if I am wrong, but the dividends of the ETF would be considered ordinary income taxable at your highest marginal rate, not dividends taxable at 15%) would be better held in a tax deferred (traditional IRA), or better yet, tax free (roth) account.

  7. enonymous says:

    And one other concern/question – of the various time to maturity US Treasury ETFs out there, would it make more sense to hold the shortest maturity (SHY), intermediate maturity (IEF), or longest maturity (TLT) ETF in a long time horizon passive index investing (lazy) portfolio (buy and hold >20 years). I understand that the price movement of the ETF will be more volatile in the longer time to maturity treasury bond funds such as TLT, but higher corresponding yields should be present too right (presuming this flattened yield curve goes back toward historical norms)?

  8. If you hold a money market in taxable then you can probably hold treasuries with similar tax consequences. Treasuries are exempt from state and local taxes on their yield. Theoretically treasuries could be taxed on capital gains. TIPS are not taxable locally. Individual TIPS bonds are not good in taxable because you pay tax on the phantom inflation interest, but you don’t get that money until the bond matures or you sell it. TIPS funds don’t have the phantom interest problem because you get paid that money as you go along. So TIPS funds are suitable for taxable if you don’t mind paying taxes.

    Typcially iBonds are recommend for taxable, but the 1.4% coupon rate is so inferior to the current TIPS rate that paying the taxes on a fund is a better deal.

    To maximize total return you generally want to hold taxable bonds in an account like an IRA or Roth IRA and equities (stocks) in taxable. That gives you the ability to tax harvest when prices drop and move sideways to similar stocks or funds. Read up on wash sales rules before engaging in this behavior

    Paul

  9. I need to fix that sentence. I was thinking of REITs as a separate asset class than US equities (29/43 = 2/3), which is technically incorrect. REITs are US equities, but it is only something like less than 5% of the Total US Stock Market by capitalization. If you include houses and such as under the “Real Estate” label, then you might not consider it a stock. But if you just use REITs, then 29 divided by 29+43 is about 40%.

  10. Off topic (sorry) – I’m concerned about leaving fairly large amounts of cash in some of these online savings accounts right now (such as ING). Any suggestions on where you would tuck about $300K right now? I’m considering CDs from BofA and treasurydirect.gov T-Bills. I live in CA and would avoid state taxes on the T-Bill option. Thanks.

  11. Epononymous – I would hold all bonds in tax-sheltered account as much as possible. More info:

    Tax efficient mutual fund placement

    Shorter-term Treasuries appear to offer the best risk/reward ratio. If you do want higher returns, consider simply owning more stocks. “Take your risk on the equity side”.

    See here for information about bond maturities and risk/returns

  12. Juan De la Vega says:

    I feel it is risky to invest in REITs in these times.
    Does anyone else feel that way?

  13. “These times” being the next 20-40 years? No, I don’t feel that way. ;)

    “These times” meaning you feel it’s risky to invest in REITs speculatively on a short-term basis (say 5 years or less)? Yes, I agree. REITs many other asset classes are risky investments for speculative purposes.

  14. REITs aren’t exactly the same thing as “Real Estate”. They have much more equity-like characteristics.

  15. What Swenson considers “real estate” is something like the TIAA-CREF Real Estate account. This fund has direct ownership of commercial real estate.

    REITs are beasts that have some correlation to real estate, stocks and bonds because all factors play a part. It’s better than full correlation to stocks though so it’s the best you can do at the moment.

  16. David Swenson’s other book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment , is something that can add a lot of depth to the ideas covered in Unconventional Success. The idea of rebalancing is often a concept that get missed. With strong sectors like energy and basic materials providing much of the performance the last couple years, it is hard to trim winners and move into unloved areas to rebalance the mix. Keep the asset allocation percentages is very important and covered pretty well when you combine both of this books.

  17. I was looking at a comparison of “lazy portfolios” and it appears the large allocation to REITs significantly lowers volatility compared to other lazy portfolios. At this time, I’m not anywhere near that 20% allocation, but hope to get up to 15% perhaps at some point in the future… (Still sitting on cash waiting for REITs to be attractive again…)

  18. Yes, I think depending on the period of history you look at, REITs have similar returns to common stocks, but aren’t correlated, so they reduce volatility. I think Rick Ferri goes into this in his books more than others that I’ve read.

  19. Larry Minton says:

    I read an article that said that a person should consider an REIT investment as being 50% equity and 50% bond. That is the way I do it in my asset allocation. I also have divided my REIT investments between the United States and international. Good luck to you.

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