No-Brainer Portfolio: Diversify Your Way to Financial Success (Bernstein)

Introduction

The No-Brainer Portfolio is a simple investment strategy created by William Bernstein. As the name suggests, it's designed to be straightforward and easy to implement, making it suitable for individual investors who want a low-maintenance approach. Let’s take a closer look at its characteristics.

ETF Composition

Source: www.lazyportfolioetf.com

The stock-to-bond ratio is 75:25. The stock portion is further broken down into 25% U.S. large-cap stocks, 25% U.S. small-cap stocks, and 25% large-cap stocks from countries outside the U.S. The bond accounts for the remaining 25%.

For U.S. large-cap stocks, ETFs that track the S&P 500 like VOO (Blackrock) or SPY (State Street) work well. For U.S. small-caps, there’s IJR (BlackRock) or VB (Vanguard). For non-U.S. stocks, we’ve selected EFA by BlackRock, which covers over 900 large-cap stocks from the EAFE region (Europe, Australia, Asia, and the Far East).

For the bond portion, we can use BND (Vanguard), which tracks Bloomberg U.S. Aggregate Float Adjusted Index. It focuses on investment-grade bonds with the current allocations of more than 85% in AAA~A and less than 15% in BBB.

Historical Performance

Source: www.lazyportfolioetf.com

• Rebalancing on January 1st each year. Dividends are reinvested.
• Fees and capital gains taxes are assumed to be zero.
• Maximum period: January 1, 1871 – September 30, 2024 (55 years)

As of the end of September 2024, the No-Brainer Portfolio has delivered an impressive return of 12.2% year-to-date, with a 24.5% return over the last 12 months. Looking at the 10-year period, the annualized return falls to 7.8%, while over 30 years, it increases to 8.1%. Over 55 years since 1970, it has maintained a solid 9.8% average annual return, which is quite respectable.

Maximum Drawdowns

Source: www.lazyportfolioetf.com

The chart above shows the maximum drawdown of the No-Brainer Portfolio over the past 55 years, from 1970 to the present. Compared to portfolios like the All Weather or Permanent Portfolio, the No-Brainer Portfolio aligns more closely with the 60/40 or Warren Buffett’s 90/10 portfolio. Only once, in 2009, did it experience a decline of over 40%. If we look at declines over 20%, there have been five instances (including -19.98% in 1998). By comparison, over the same period, Warren Buffett’s 90/10 portfolio saw three declines of over 40% and six of over 20%.

Backgrounds

Creator: William J. Bernstein, an American financial theorist and investment advisor. Originally a neurologist, he retired to focus on finance. He has authored several books, including “The Intelligent Asset Allocator” and “The Four Pillars of Investing.” In addition to the No-Brainer Portfolio, he also created the Coward's Portfolio.

Logic: Unlike All Weather, 60/40, Permanent, or Warren Buffett's 90/10 portfolio, which all use a single ETF to cover equities despite varying stock ratios, the No-Brainer Portfolio divides the stock portion equally among three ETFs. Just as stocks and bonds have cyclical periods of popularity, U.S. large-cap, U.S. small-cap, and international large-cap stocks also rotate in favor over time. By splitting equities into three ETFs and rebalancing regularly to avoid over-concentration, investors can benefit from the automatic effect of buying low and selling high.

Rebalancing: According to Bernstein’s research, rebalancing too frequently - like on a monthly basis - is not recommended due to the short-term persistence of individual ETF returns. He observed little difference between annual and quarterly rebalancing. He also mentioned both time-based rebalancing (rebalancing after a set period) and threshold-based rebalancing (when an asset deviates significantly from its target allocation), noting that each has its pros and cons without one being definitively better. For those worried about rebalancing frequency or methods, Bernstein’s advice is clear: “Don't sweat this one too much. The returns differences among various rebalancing strategies are quite small in the long run.”

Thoughts on the No Brainer Portfolio

Returns: Let’s compare the returns of the five portfolios introduced so far. Overall, its returns have been higher than the All-Weather and Permanent Portfolios but lower than Warren Buffett's 90/10 Portfolio, resulting in performance roughly on par with the 60/40 Portfolio.

Source: Compiled by Neo, as of late September 2024

Defense: Again, we compared the five portfolios. The table below shows the worst and second-worst maximum drawdowns and their timing over the past 55 years (since 1970). Unlike returns, the No-Brainer Portfolio experienced higher maximum losses than the All-Weather and Permanent Portfolios, but lower than Warren Buffett’s 90/10 Portfolio. Notably, it fared worse than the 60/40 Portfolio.

Source: Compiled by Neo, as of late September 2024

Conclusion

The No-Brainer Portfolio is an investment strategy created by William Bernstein, renowned for his book “The Intelligent Asset Allocator.” Unlike the other four portfolios we’ve explored so far (All-Weather, 60/40, Permanent, and Buffett's 90/10) that rely on a single equity ETF, the No-Brainer allocates 25% each to U.S. large-cap, U.S. small-cap, and international large-cap stocks, aiming for a more balanced approach.

For instance, the 60/40 or Buffett's 90/10 Portfolio using the S&P 500 ETF lacks exposure to U.S. small-cap or international stocks. Even if one were to substitute the S&P 500 in All-Weather or 60/40 with a global stock ETF like VT, large-cap U.S. stocks would still constitute the dominant portion of the portfolio. Therefore, if U.S. large-caps decline while U.S. small-caps or international large-caps rise, these other strategies might underperform compared to the No-Brainer.

That said, a 30-year comparison reveals an anomaly. The 60/40 Portfolio, which allocates 60% to equities solely through the S&P 500 ETF, has outperformed the No-Brainer Portfolio, which holds a 75% equity stake across three ETFs, by about 0.5% to 1.2% annually in 1-year, 5-year, 10-year, and 30-year returns. Typically, a higher equity allocation yields higher returns, but not here.

Conversely, over the past 55 years, the No-Brainer's two largest historical drawdowns were 7-10% higher than those of the 60/40 Portfolio. Usually, lower returns coincide with lower drawdowns, but that wasn't the case here. Given similar returns, investors would naturally favor the portfolio with lower risk, and by this 30-year dataset, the No-Brainer fell short against the 60/40 Portfolio.

The reason for this difference is straightforward. Over the past 30 years, U.S. large-caps, represented by the S&P 500, outpaced U.S. small-caps and international large-caps significantly, allowing the 60/40 Portfolio, despite a lower equity allocation, to outperform the No-Brainer. Additionally, when U.S. large-caps faltered, U.S. small-caps and international stocks often declined even more.

While it’s possible that U.S. large-cap growth could slow, giving way to U.S. small-cap or international large-cap growth, the future remains uncertain. Yet, with advancements in AI, autonomous driving, robotics, and biotechnology, where U.S. large companies continue to lead, it’s plausible that U.S. large-cap stocks might continue to perform well in the coming years.

All-in-all, the No-Brainer Portfolio's lower returns and risk profile compared to the other four portfolios make it slightly less attractive in the current market conditions. But we never know!

Thanks for reading. I wish you success in making smart investments!

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