'Lazy portfolios' win again, beat S&P 500! (Paul B. Farrell)

By Paul B. Farrell, MarketWatch

Last Update: 7:47 PM ET Jan 16, 2007

ARROYO GRANDE, Calif. (MarketWatch) -- No fifth year in the bull run? That was last week's red flag. So how do you protect yourself? Let's begin with that good old Wall Street adage: "You make your money in stocks, you keep it in bonds." Here's the modern version: "You make money in stocks, you keep it in a lazy portfolio!"

Why? Two reasons. Unless you're working full-time in the financial world, you don't have the skills, tools, information, time or interest in playing the market, especially the bond market. And even if you do play the market, the odds are you'll lose because the more you trade the less you earn; transaction costs and taxes kill returns. So for 94 million out of America's 95 million investors, being a lazy investor is the best defensive strategy.

In fact, even the hotshots working full-time in the financial world follow the same strategy with the bulk of their assets. It's their biggest secret. Mutual fund managers making an average $400,000-plus playing the market with your money, often lock away the bulk of their retirement assets in safe, untouchable portfolios using a variation of a lazy portfolio strategy. Why not, they're no dummies, they've got families to protect too.

And if you haven't figured it out from reading about lazy portfolios the past five years since we've written the book and updated them periodically, lazy investing is nothing more than the good old "Modern Portfolio Theory" put into action: Simple, well-diversified portfolios of three to 11 no-load index funds, either mutual funds or ETFs.

But, unfortunately, Wall Street doesn't want you to use this Nobel Prize-winning strategy because it can't rake off enough in transactions fees from index funds.

So how'd the 'Lazy Portfolios' do last year? Same old dull, boring results as the past five years! They beat the pants off the S&P 500, that's what. Morningstar tallied the results for us, with the Aronson portfolio the three- and five-year winner, and Swensen's portfolio the 2006 winner. Take a close look folks:

Aronson Family Portfolio: 11 funds

Ted Aronson heads up AJO Partners, managers of $28 billion, all tax-exempt institutional retirement funds, no retail funds you can buy. I first ran across Ted in a Barron's interview. He also headed a professional society of 75,000 American money managers. Ted's one of the rare managers who'll tell you where his own money is invested ... in a lazy portfolio. My guess is your fund manager (like the other 99.9% out there) is too embarrassed to tell you, afraid you won't like what you see.

"All of my family's retirement money is in AJO funds," says Ted, "but because the fund trades a lot, it's not suitable for taxable investments. So all our family's taxable money is in Vanguard's no-load index funds." Read Five Questions For ... Ted Aronson.

His average 13.3% annual return was twice the S&P 500 (6.2%) the past five years, and he beat it on a one- and three-year basis too. So, he's "sticking with my very heavy equity/very international blend of funds in 2007!" He's very aggressive: The other portfolios have 30-40% in bonds, Ted has only 20%.

Fund	Allocation	1-year return	3-year annualized return	5-year annualized return
Vanguard 500 Index VFINX	15%	15.64%	10.307%	6.07%
Vanguard Emerging Markets Stock Index VEIEX	20%	29.07	29.06	25.69
Vanguard European Stock Index VEURX	5%	33.12	20.69	14.88
Vanguard Extended Market Index VEXMX	10%	14.27	14.37	11.95
Vanguard High-Yield Corporate VWEHX	5%	8.24	6.47	7.55
Vanguard Inflation-Protected Securities VIPSX	10%	0.43	3.71	7.04
Vanguard Long-Term U.S. Treasury VUSTX	5%	1.74	5.13	6.84
Vanguard Pacific Stock Index VPACX	15%	11.81	17.66	15.38
Vanguard Small Cap Growth VISGX	5%	11.95	12.18	11.28
Vanguard Small Cap Value Index VISVX	5%	19.24	16.05	12.96
Vanguard Total Stock Market Index VTSMX	5%	15.51	11.26	7.42
Total portfolio	100%	15.89	15.40	13.30
S&P 500 Index	100%	15.79	10.44	6.19

No-Brainer Portfolio: 9 funds

Dr. William Bernstein is the author of the "Intelligent Asset Allocator" and "The Four Pillars of Investing." He's also a physician, neurologist and financial adviser to high-net-worth individuals. I first saw his portfolio seven years ago in one of his SmartMoney columns. Like the other lazy portfolios, no new asset allocations. And he's still beating the S&P 500's three and five-year averages plus close this past year.

Fund	Allocation	1-year return	3-year annualized return	5-year annualized return
Vanguard Emerging Markets Stock Index	5%	29.07%	29.06%	25.69%
Vanguard European Stock Index	5%	33.12	20.69	14.88
Vanguard Pacific Stock Index	5%	11.81	17.66	15.38
Vanguard REIT Index VGSIX	5%	35.07	25.49	22.70
Vanguard Short-Term Investment Grade Index VFSTX	40%	4.99	3.09	3.74
Vanguard Small Cap Index NAESX	5%	15.66	14.19	11.64
Vanguard Small Cap Value Index	10%	19.24	16.05	12.96
Vanguard Total Stock Market Index	15%	15.51	11.26	7.42
Vanguard Value Index VIVAX	10%	22.15	14.68	9.54
Total portfolio	100%	14.70	11.35	9.37
S&P 500 Index	100%	15.79	10.44	6.19

Coffeehouse Portfolio: 7 funds

Bill Schultheis is a true visionary. A former Salomon Smith Barney broker and the author of "The Coffeehouse Investor," he launched his portfolio in 1999 when Wall Street was betting heavy on tech and dot-coms. They laughed at his 40% bond allocation. But nobody laughed in the bear years of 2000-2002 when this lazy portfolio was beating the S&P 500 by 15 percentage points all three years.

The beauty of this one is its utter simplicity, kind of like a freshman algebra equation you never forget: You put 40% in an intermediate bond index and 10% in each of the six stock funds. And it wins in bull and bear markets.

Bill says the market's fully valued and so he sees "lackluster returns" the next few years, making it more important than ever before to stick with a low-cost, tax-efficient portfolio.

Fund	Allocation	1-year return	3-year annualized return	5-year annualized return
Vanguard 500 Index	10%	15.64%	10.30%	6.07%
Vanguard REIT Index	10%	35.07	25.49	22.70
Vanguard Small Cap Index	10%	15.66	14.19	11.64
Vanguard Small Cap Value Index	10%	19.24	16.05	12.96
Vanguard Total Bond Market Index VBMFX	40%	4.27	3.63	4.61
Vanguard Total International Stock Index VGTSX	10%	26.64	20.93	16.08
Vanguard Value Index	10%	22.15	14.68	9.54
Total portfolio	100%	15.15	11.61	9.74
S&P 500 Index	100%	15.79	10.44	6.19

Yale University Lazy Portfolio: 5 funds

David Swensen is the manager of Yale University's endowment fund and author of "Unconventional Success." He's had incredible returns of roughly 16% annually for the past two decades. But Swensen warns us that institutional managers like him have many advantages unavailable to the vast majority of America's 94 million investors.

His five-fund portfolio was the overall "Lazy Portfolio" winner in 2006, beating the S&P 500 17.6% to 15.8%, and also on a three and five year basis.

Fund	Allocation	1-year return	3-year annualized return	5-year annualized return
Vanguard Inflation-Protected Securities	15%	0.43	3.71	7.04
Vanguard REIT Index	20%	35.07	25.49	22.70
Vanguard Short-Term Treasury Index VFISX	15%	3.77	2.18	3.36
Vanguard Total International Stock Index	20%	26.64	20.93	16.08
Vanguard Total Stock Market Index	30%	15.51	11.26	7.42
Total portfolio	100%	17.62	13.55	11.54
S&P 500 Index	100%	15.79	10.44	6.19

Margaritaville Portfolio: 3 funds

Scott Burns, co-author of the bestselling "Coming Generational Storm," is a popular Dallas Morning News financial columnist. He developed his original "Couch Potato Portfolio" 15 years ago.

When it slipped in recent years he modified his strategy with the Margaritaville Portfolio: "One part total stock index, one part international stock index and one part inflation-protected Treasury securities."

How about 2007? "International equities, still cheaper than U.S. equities, could have another good year. The likely drag is from domestic equities." Still, the allocations hold steady. The portfolio beat the S&P 500 on 3- and 5-year average annual returns, though it was slightly off in 2006.

Fund	Allocation	1-year return	3-year annualized return	5-year annualized return
Vanguard Inflation-Protected Securities	33.3%	0.43	3.71	7.04
Vanguard Total International Stock Index	33.3%	26.64	20.93	16.08
Vanguard Total Stock Market Index	33.3%	15.51	11.26	7.42
Total portfolio	100%	14.19	11.97	10.18
S&P 500 Index	100%	15.79	10.44	6.19

All data: Morningstar Inc. as of Dec. 31.

But which one is best for you? The truth is, any one is better than wasting your time chasing hot stocks and the other 8,000-plus actively managed funds, 80-85% of which underperform the market every year.

So in the long run, any one of these five is a better choice than virtually any load fund. You can read about the details in my "Lazy Person's Guide to Investing."

Better yet, try this strategy, use your common sense and create your own portfolio of three to 11 no-load, low-cost index funds, after reviewing these five models. But whatever you do, please forget about guessing economic cycles and playing the market; it's a no-win game, you're wasting your time, your retirement nest egg and your future