One result: Despite the data supporting index funds, many individual investors struggle to keep things simple. Seeing the results of Yale and its peers, they worry that a simple portfolio of index funds might be too simplistic. They feel compelled to add more “interesting” investments to their mix.
But as Swensen himself
pointed out, what works for a multi-billion-dollar endowment probably won’t work for an individual investor. A complex portfolio, in fact, is likely to be counterproductive for individual investors. Swensen dedicated an entire
book to this topic. The primary reason cited by Swensen: The types of investments available to institutions like Yale simply aren’t open to individuals.
There are other reasons complexity can be a problem. A portfolio of complicated investments makes it difficult to grasp what you own. Does your portfolio consist mostly of stocks or mostly of bonds? The simpler a portfolio, the easier it is to answer that question.
Research indicates that this high-level split is the most important factor in driving a portfolio’s risk and return, so it’s critical to monitor where your portfolio stands. Owning more funds—and more complex ones—makes that harder to do.
Another issue with complex investments: They’re typically more expensive. That’s one reason the three-fund approach is so popular. Its three components are typically the three least expensive options available from major fund companies. That’s important because there’s a
correlation between lower cost and better performance. As the late Jack Bogle used to
say, “You get what you
don’t pay for.”
Finally, a complex portfolio is generally less predictable than a simpler one. That’s because newfangled investments, as well as private investment funds, offer less of a track record to evaluate. A related issue: Because it’s hard to know how a complex investment will perform, it’s also difficult to know how it will correlate with a portfolio’s other assets.
