My favorite asset allocation uses a three-fund portfolio consisting of U.S. stocks, international stocks, and U.S. bonds. There are certainly other similar asset allocations that use more or fewer asset classes. These portfolios can be classified under the moniker “lazy portfolios.”
One lazy portfolio is the “Coffeehouse Portfolio,” popularized by financial advisor Bill Schultheis in the best-selling book The Coffeehouse Investor. Let’s take a look at the Coffeehouse Portfolio and see if it makes sense for you.
The Coffeehouse Investor
First published in 2001 and reprinted in 2013, the Coffeehouse Investor outlines three core principles to investment success:
- Asset Allocation – this is where the Coffeehouse Portfolio comes in
- Approximate the Stock Market Average – don’t pick stocks or mutual funds and invest in low-cost index funds
- Saving – selecting a savings rate that will enable you to reach your financial goals
These are common-sense principles, but the style in which he presents these principles made his book and approach very popular. His book subtitle is “How to Build Wealth, Ignore Wall Street and Get On With Your Life.” While today that might seem like a pretty popular slogan, that wasn’t the case in 2001. In the age of star fund managers, simple, uncomplicated investing using low-cost index funds was not a commonly recommended strategy among financial advisors. So Mr. Schultheis should be given a lot of credit for adopting a passive index approach to financial management back in 2001.
The Coffeehouse Portfolio
The Coffeehouse Portfolio consists of 7 funds. It starts with a 60/40 stock/bond split, with the fixed income portion of the portfolio being put into a total bond fund such as Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) or Fidelity® U.S. Bond Index Fund – Premium Class.
The 60% in stocks is split evenly between six different index funds, a large-cap fund, a large-cap value fund, a small-cap fund, a small-cap value fund, an international fund, and a REIT fund.
| Asset Class | Portfolio Weight |
| Large Cap | 10% |
| Large Cap Value | 10% |
| Small Cap | 10% |
| Small Cap Value | 10% |
| International | 10% |
| REIT | 10% |
| Total Bond | 40% |
Building a Coffeehouse Portfolio with Vanguard
Here’s how you would build the Coffeehouse Portfolio with Vanguard. Using Admiral Shares, the Coffeehouse Portfolio can be built with a total expense ratio of just 0.067%, or $670 on a $1,000,000 portfolio.
| Asset Class | Vanguard Fund | Ticker | Expense Ratio |
| Large Cap | Vanguard Large-Cap Index Fund | VLCAX | 0.06% |
| Large Cap Value | Vanguard Value Index Fund | VVIAX | 0.06% |
| Small Cap | Vanguard Small-Cap Index Fund | VSMAX | 0.06% |
| Small Cap Value | Vanguard Small-Cap Value Index Fund | VSIAX | 0.06% |
| International | Vanguard Total International Stock Index Fund | VTIAX | 0.11% |
| REIT | Vanguard REIT Index Fund | VGSLX | 0.12% |
| Total Bond | Vanguard Total Bond Market Index Fund | VBTLX | 0.05% |
Performance of the Coffeehouse Portfolio
Using the historical market returns from Portfolio Visualizer, here’s how the Coffeehouse Portfolio has performed since its introduction in 2001, along with a 60/40 Total Stock Market / Total Bond Market Portfolio.
| Year | Coffeehouse Portfolio | 60/40 Portfolio |
| 2001 | 1.88% | -3.21% |
| 2002 | -5.55% | -9.27% |
| 2003 | 23.55% | 20.40% |
| 2004 | 13.80% | 9.21% |
| 2005 | 6.24% | 4.55% |
| 2006 | 15.15% | 11.01% |
| 2007 | 2.63% | 6.06% |
| 2008 | -20.21% | -20.20% |
| 2009 | 20.26% | 19.59% |
| 2010 | 14.68% | 12.82% |
| 2011 | 2.02% | 3.60% |
| 2012 | 11.93% | 11.37% |
| 2013 | 14.74% | 19.11% |
| 2014 | 9.33% | 9.76% |
| 2015 | -0.93% | 0.29% |
| 2016 | 9.44% | 8.52% |
| 2017 | 6.31% | 8.13% |
Here’s how the Coffeehouse Portfolio has done compared to its benchmark asset allocation in chart form:
From 2001-2016, the Coffeehouse Portfolio has returned 6.9%, while a 60/40 total stock / total bond portfolio has returned 5.9%.
Variations On The Coffeehouse Portfolio
The Coffeehouse portfolio has more bonds than the typical investor would hold, especially for younger investors. For example, the target-date funds for Fidelity and Vanguard hold only 10% bonds until an investor is 45. Even investors in retirement should hold at least a 50/50 portfolio according to the Trinity University study, and some have even argued for a more aggressive portfolio in retirement.
Admittedly, the Coffeehouse portfolio is tilted towards small-cap and value stocks, which historically have had higher expected returns and higher volatility. One way to tweak the portfolio would be to reduce your exposure to bonds and split the remaining portfolio evenly between the six funds. For example, you could hold 10% bonds and 15% in the other six funds. This portfolio would probably be more aggressive than the standard three-fund portfolio, which may be desirable for some investors. Be careful about how much risk you think you can handle, though.
Conclusion
The Coffeehouse Portfolio is a reasonable asset allocation for investors. The most important aspect of any asset allocation is your ability to stick with it. It is tempting to tweak your asset allocation towards the asset classes which have done well most recently.
The Coffeehouse Portfolio was introduced in 2001, when the stock market was falling after the tech bubble burst. This might explain the appeal of a 40% bond portfolio. Now that the stock market is booming, many investors are more interested in a more stock-heavy portfolio. The key is not to use the original Coffeehouse portfolio after a bear market, and then switch to a more stock-heavy allocation when the stock market is rising.
What do you think of the Coffeehouse Portfolio? Do you like its combination of a high bond allocation and tilt towards small cap and value stocks?
Very sensible advice; the power of low fee index funds with a slight tilt toward small caps really should give you an investing advantage over the years. Well done.
I tilt to both small and value, but with a much smaller bond allocation (10%). The coffeehouse portfolio also has a pretty small international allocation, but I guess that’s one way to keep things simple.
Thanks for sharing — it’s been awhile since I have read specifically about this one. I believe Dr. Dahle had it as one of the 150 allocations better than yours. I’m not sure it’s better than mine, but one could do much worse. Great to see how inexpensive it is with my favorite brokerage.
Cheers!
-PoF
Interesting, thanks for sharing. Paul Merriman has recommendations on his website for similar (though slightly more complicated) portfolios. For example, his aggressive recommendation for a portfolio of Fidelity mutual funds has 10 different no-load, low-expense ratio funds. There is a mix of large and small cap, growth and value, domestic and international. He claims such a mix could help squeeze a couple more percentage points versus an S&P 500 index fund. I am curious to see what you think of such a portfolio vs something like the 3-portfolio fund.
I understand why people slice and dice but I don’t personally think it’s necessary for most physicians.
What about non-physicians?
I was with you until the end: “The key is not to use the original Coffeehouse portfolio after a bear market, and then switch to a more stock-heavy allocation when the stock market is rising.”
The advice not to do something sounds a lot like advice to do the opposite. Which would involve market timing on some level. In other words, it suggests the opposite approach would be superior to the bad approach. Adopt a more stock heavy portfolio during bear markets, and transition to more bonds the higher the market goes (i.e. now and in the future until the next bear market).
Granted, you also say the most important thing is to pick something and stay with it. So what’s your take between the two?
(To be clear I’m not talking about selling one to buy the other…but for instance using new income investment to bias the ratio gradually.)
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