In my previous posts in this series, I talked about Portfolio Types, TIPS and REITs, and Approximating a Portfolio.

Now that we have discussed different types of Asset Allocation and you know about Talking the Talk I want to discuss a more advanced portfolio.

This is the Coffeehouse Portfolio, created by Bill Schultheis, also known as The Coffeehouse Investor.  Amazon Link

(I have no financial relationship with Bill Schultheis or Amazon.)

What is a Coffeehouse Portfolio?

One of the reasons I am exploring this portfolio is because it is a somewhat more advanced portfolio from the 2 and 3 fund lazy portfolios I’ve discussed previously. I read this book when I was first getting started with learning about how to allocate stocks and bonds. If I recall correctly, my wife and I were on our honeymoon in Aruba and I was sitting on a beach reading this book. I tried to get my wife to read the book as well, but she doesn’t really like reading about stuff like this. However, I bookmarked certain pages for her to read which I thought were important and so she understood the general gist of the book.

In general, the Coffeehouse Portfolio is pretty similar to the lazy 2 and 3 fund portfolios, but offers a little more flexibility in that it does not designate specific funds.  You can find the overall split in a pie chart on the boglehead wiki, but here it is in text format:

Boiled down to its simplest form, it’s your general 60/40 Stock/Bond split, where it differs from the other portfolios is how it allocates the 60% stocks.

Whereas the other portfolios designate large index funds of either the US or International Stock Index Funds, the Coffeehouse Portfolio designates more specific asset classes categories:

“Stocks” ~60%
Large Blend (10%)
Large Value (10%)
Small Blend (10%)
Small Value (10%)
Total International (10%)
REIT (10%)

“Bonds” ~40%
Intermediate Term Bond Index 40%

Wait, what does Large Blend, Large Value, etc. mean?

Basically there are two adjectives here:

Large/Mid/Small:

This refers to how big the “market capitalization” of the funds are. In a general sense, it approximates the net worth of the company.

Large = ~ $10 billion or above
Mid = ~$2 billion to $10 billion
Small = less than $2 billion

In general, companies with larger market caps are less volatile than those with small market caps. However, small market caps have a higher chance for growth.

Value versus Growth versus Blend:

Value = “Omg it’s on sale!” – felt to be low-priced relative to any host of metrics like its earnings, dividends, or book value. However, chance of growth is lower.
(think: “cheap” or “good deal”) — slow and steady

Growth = “I believe in you!” – felt to be expensive relative to any host of metrics like its earnings, dividends, or book value. However, chance of growth is higher.
(think: “expensive, but could significantly more expensive”) — please grow

Blend = combination of both

So it’s basically a 60/40 portfolio?

In the most simplistic fashion, yes, that’s exactly what it is.

It’s actually most similar to Rick Ferri’s “Core Four” that I discuss in my Portfolio Types post, mostly because they both use REITs. However, whereas Rick Ferri specifies the exact funds to use, the Coffeehouse Portfolio just designates the asset class categories. This allows you to approximate this portfolio a little easier, no matter what funds your 401k uses.

In my previous post, Approximating a Portfolio, you could see it was pretty difficult to get a similar asset allocation split for the Taylor Larimore’s portfolio. However, because the Coffehouse portfolio uses general asset class categories rather than specific funds, your options are increased.

In that example, you could approximate with:

“Stocks” ~60%

Large Blend (10%) — Vanguard 500 Index Fund (0.16%) – 501 stocks
Large Value (10%) — Vanguard Windsor II Fund (0.34%) – 271 stocks
Small Blend (10%) — Vanguard Small-Cap Index Fund (0.20%) – 1470 stocks
Small Value (10%) — Vanguard Small-Cap Value Index Fund (0.20%) – 858 stocks
Total International (10%) — Vanguard International Growth Fund (0.47%) – 164 stocks
REIT (10%) — Unfortunately, there is no REIT option.

“Bonds” ~40%

Intermediate Term Bond Index 40% — Vanguard Total Bond Market Index Fund (0.16%) – 8225 bonds

There is no REIT option, but you can approximate the fund relatively well overall. If you wanted to keep the 60/40 distribution, you could spread out the 10% from the REIT into the other funds in a balanced fashion, making them 12% each, so it looks like this:

“Stocks” ~60%

Large Blend (12%) — Vanguard 500 Index Fund (0.16%) – 501 stocks
Large Value (12%) — Vanguard Windsor II Fund (0.34%) – 271 stocks
Small Blend (12%) — Vanguard Small-Cap Index Fund (0.20%) – 1470 stocks
Small Value (12%) — Vanguard Small-Cap Value Index Fund (0.20%) – 858 stocks
Total International (12%) — Vanguard International Growth Fund (0.47%) – 164 stocks
REIT (0%) — Not available.

“Bonds” ~40%

Intermediate Term Bond Index 40% — Vanguard Total Bond Market Index Fund (0.16%) – 8225 bonds

I see, so it provides more flexibility because it is asset class categories rather than individual funds… So it’s better then right?

It’s not “better” per say, it’s just more detailed. It’s not very different from the other portfolios I talked about. Before I read his book, I was a fan of Taylor Larimore’s 3 fund portfolio and was planning to use that pretty much forever. Reading his book made me consider his portfolio because of the flexibility. However, in the end I opted to:

KISS (Keep It Simple Stupid)

Even in this small way, you are still making certain “picks” because there are more options for Large Blend, Large Value, Small Blend, and Small Value. More funds = easier to see which funds are doing “better” and may cause you to move money around too much in an attempt to try to “beat the market”. That is exactly what we don’t want to do. It’s good to understand all of these asset class categories in the general sense, but just remember when you focus on individual asset class categories you are narrowing your scope, just like when you pick an individual stock — or pick an individual number on the roulette table.

In a general sense, if you want to index the entire US stock market, then buy the fund closest to that: Vanguard Total Stock Market Index Fund Investor Shares (VTSMX)

That one fund by itself already provides “exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.”

More important than that:

You need to know yourself.

I know myself. 

Given the opportunity I will try to tinker with things and try to maximize any gains I see — which will lead to me trying to pick better individual Large Blend, Large Value, Small Blend, and Small Value funds… and then I will probably spiral into trying to pick individual stocks. The slippery slope becomes even more slippery. To be honest, I like the Coffeehouse Portfolio better than Taylor Larimore’s 3 Fund Portfolio in terms of its overall asset allocation. However,  rather than tempt myself, I opted to just set it and forget it. For this reason, I’m sticking with a Three Fund Portfolio and just rebalancing every year, although I may add in a small % of REITs, like I discussed before.

TL;DR

The Coffeehouse Portfolio is most similar to Rick Ferri’s Core Four.

However, it lists asset class categories rather than individual funds.

This provides flexibility, but also is a *small degree* of stock picking.

Know yourself, you are your own worst enemy.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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