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At its most basic level, bread contains four core ingredients, each serving a specific role in the chemistry and structure of the loaf.
Flour provides structure. Flour’s key proteins combine with water to form gluten. Gluten creates the stretchy network that traps gas bubbles and allows bread to rise.
Water hydrates the flour and activates gluten formation. Water allows proteins and starches in the flour to interact, forming dough.
Yeast “leavens” the bread (makes it rise). Yeast is a living microorganism that eats sugars, produces carbon dioxide to inflate the dough, and releases flavors that add a typical “bready” taste.
Salt controls fermentation and improves flavor. Without salt, bread tastes flat, and the dough becomes sticky and weak.
Those are the “core four.” But we can (and many people do) add more ingredients:
- Sugar/honey for flavor, feeding the yeast, and browning the dough
- Fat (butter/oil/dairy) for tenderness and richness
- Eggs for richness and structure
- Whole grains / seeds for flavor and nutrition
Bread isn’t complex. Each ingredient has an important role.
But what’s the point? Why am I writing about bread?
- It’s simple. There aren’t dozens of ingredients.
- Every ingredient has a specific job. A specific domain. A reason why it’s in the recipe. And, by and large, those jobs do not overlap.
- Yet, in varying proportions, these few unique ingredients can create many different outcomes.
The Bakery Portfolio
I am currently looking at a prospective client’s portfolio constructed using ~10-20% allocations to each of the following eight Vanguard funds:
- VTI – Total US Stock Market
- VOO – S&P 500
- VV – Large Cap
- VUG – Growth Stocks
- MGK – Mega Cap Growth
- VGT – Information Sector
- QQQM – Nasdaq 100
- VO – Mid Cap ETF
Some of you might think, “Those are all different descriptions. Growth vs. Information vs. Mega Cap. S&P 500 vs. NASDAQ. They’re different! It seems like each fund must provide different diversification, right?”
But that’s not the case. This is a portfolio of various wrappers, all of which hold the same stocks. If I instead put this portfolio in bread terms, it’s as if the recipe calls for:
- 2 cups bread flour
- 1 ½ cups all-purpose flour
- 1 cup high-gluten flour
- ¾ cup strong white flour
- ½ cup 00 pizza flour
- ½ cup artisan baking flour
- ¼ cup premium organic white flour
No water. No yeast. No salt. No sweetener. Just flour.
This isn’t good bread, and that wasn’t a good portfolio.
A Clear Job – And Just One Job
I would much rather advocate for a portfolio where every “ingredient” has a clear job…and just one job. We don’t need 100 “ingredients,” and we don’t need too many ingredients doing the same thing (“10 types of flour”).
Any portfolio – but especially a retirement portfolio – needs four vital, distinct ingredients.
- Appropriate risk level. Your “stocks vs. bonds vs. other assets” mix matters far more than which specific funds you pick. This asset allocation decision should be related to how much money you need from the portfolio and when you need it.
- Broad diversification. You want to avoid concentrated sector bets, stock picking, and redundant funds that own the same companies. A retirement portfolio should resemble the entire market. You can accomplish this with one fund!
- Low costs. No explanation needed.
- Behavior you can stick with. Your portfolio should be simple enough that you can: understand it, tolerate it during crashes, and stick with it for decades. If you need some “flavor” in there to make it tolerable, so be it. Some people need cinnamon and raisins in their bread. Some investors need an allocation to gold, to Costco stock, to the aerospace sector, etc. etc…I can live with that as long as it makes you not jump off the ride.
Know your ingredients and know why you’re using them. Most investors, I think, make it more complex than it needs to be.
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