Coffeehouse Portfolio: Simple and Diversified

Simple retirement portfolios make life easy. Some people call them lazy portfolios because you pick index funds, set the allocation, and rebalance periodically. There are only a few steps; they do not need constant review or fine-tuning, like managing a stock portfolio. An even easier method is to pick a pre-defined asset allocation from one of the many choices, such as the Coffeehouse Investor Portfolio.

This investing strategy was popularized by Bill Schultheis, a financial advisor and author of “The Coffeehouse Investor,” which was issued about 25 years ago in 1998. A new book was published in 2020, called “The Coffeehouse Investor’s Ground Rules: Save, Invest and Plan for a Life of Wealth and Happiness.” The second book shares stories about investors aged 23 to 90 years old.

The source of the coffeehouse portfolio strategy is these books. Bill Schultheis was an early proponent of using passive index funds, like Vanguard, at a time when actively managed funds and star fund managers ruled the roost. 

However, the Coffeehouse Investor portfolio strategy is probably less popular today due to the decades-long bull market in tech stocks. But the principles and underlying portfolio strategy for retirement planning are still relevant today. Given sufficient time the long-term returns permit a person to attain $1 million for retirement.

What is the Coffeehouse Portfolio?

The Coffeehouse Investor portfolio strategy focuses on saving for retirement, using passive index funds, uncorrelated asset classes, diversification, low expense ratios, and capturing as much of the market’s return as possible. These are all sound principles for retirement planning a specific age.

The objective is to maximize return while minimizing costs and complexity to produce consistent, long-term total returns.

As Bill Schultheis explains in his book, only about 14% of actively managed mutual funds beat the stock market on average over 3-, 5-, and 10-year periods. To attain the objective, he provides three fundamental principles,

• Don’t put all your eggs in one basket
• There is no such thing as a free lunch
• Save for a rainy day

In his second book, Bill Schultheis simplifies the three ground rules for the pursuit of wealth and happiness,

• Save
• Invest
• Plan

The rules are simple and mean:

1. Diversify your assets to maximize your chances of reaching your financial goals with minimum risk.
2. Don’t try to beat the market. Capture the entire return of each asset class and leave it at that.
3. Develop a long-term plan setting your saving and spending levels.

Asset Classes

The actual portfolio is a variation of the 60% equities / 40% bonds portfolio. However, the Coffeehouse portfolio takes the stock allocation, splitting it into six different asset classes: a large-cap fund, a large-cap value fund, a small-cap fund, a small-cap value fund, an international stock fund (ex-US), and a real estate investment trust (REIT) fund. The bond asset allocation is simply a total bond index fund. The table below outlines portfolio weightings and asset classes in the Coffeehouse portfolio.

Weighting	Asset Class
10%	U.S. Large Cap Equities
10%	U.S. Large Cap Value
10%	U.S. Small Cap
10%	U.S. Small Cap Value
10%	International Equities (ex-US)
10%	REITs
40%	U.S. Total Bond Fund

The asset allocation tilts the portfolio towards value stocks. That said, the actual portfolio asset class breakdown in the Coffeehouse Investor strategy is possibly too conservative for some people. Young people starting to save for retirement may want a more aggressive approach. But it has worked overtime with relatively low volatility, as seen below.

Using Vanguard Funds

The Coffeehouse portfolio is easily implemented using index funds or ETFs or Vanguard. Alternatively, matching funds from BlackRock, Schwab, or Fidelity can be used. The table below lists the asset class and funds with their expense ratio using seven asset classes. 

Asset Class	Vanguard Index Fund	Expense Ratio	Vanguard ETF	Expense Ratio
U.S. Large Cap Equities	VFINX	0.14%	VV	0.04%
U.S. Large Cap Value	VIVAX	0.17%	VTV	0.04%
U.S. Small Cap	NAESX	0.17%	VB	0.05%
U.S. Small Cap Value	VISVX	0.19%	VBR	0.07%
International Equities (ex-US)	VGTSX	0.17%	VXUS	0.07%
REITs	VGSIX	0.26%	VNQ	0.12%
U.S. Total Bond Fund	VBMFX	0.15%	BND	0.03%

An investor using Admiral shares will have a lower expense ratio. Alternative fund choices exist too. For example, the VFINX fund can be switched out with VLACX, and VGTSX can be replaced with VFWSX.

Or the VV ETF can be changed with the VOO ETF, and the VXUS ETF can be swapped with the VEU ETF.

Another version of the Coffeehouse portfolio uses eight asset classes, dropping the small-cap value category and replacing it with an international small value fund and adding emerging markets. This version will be more aggressive with greater international exposure.

The popularity of the Coffeehouse Investor Portfolio

The main reason for the surge in popularity of the Coffeehouse Investor portfolio was its performance during the dot-com crash from March 2000 to October 2002 compared to the S&P 500 Index and the famous 60% total stock / 40% total bond portfolio.

The table and chart below compare the returns and volatility of the Coffeehouse portfolio (portfolio 1 – blue line) versus the 60% total stock / 40% total bond portfolio (portfolio 2 – red line) and 100% U.S. large-cap growth (portfolio 3 – orange line). 

We assume the portfolios are rebalanced annually. Focusing on the compound annual growth rate (CAGR), standard deviation, and max drawdown numbers, it is clear why the Coffeehouse Investor portfolio became popular for many small investors who were probably overexposed to U.S. large-cap growth stocks at the time. The portfolio had a positive return with a lower standard deviation and max drawdown compared to the 60/40 and all stock portfolios.

Portfolio Returns During the Dot-Com Crash (March 2000 – October 2002)

The Coffeehouse Investor portfolio sometimes performs poorly compared to the 60% total stock / 40% total bond and other portfolios. For instance, the recent COVID-19 pandemic bear market severely punished REITs, which would have been a significant headwind for the Coffeehouse portfolio.

Portfolio Returns from January 2000 – June 2021

How does the Coffeehouse Investor portfolio do over more extended periods assuming a buy-and-hold strategy in a retirement plan? We ask this question since there are many choices for retirement portfolio strategies. In this comparison, we examine the Coffeehouse Investor Portfolio (portfolio 1 – blue line), the 60% total stock / 40% total bond (portfolio 2 – red line), and the 3-fund Boglehead portfolio (portfolio 3 – orange line). 

We assume the portfolios are rebalanced annually. Again, we focus on the compound annual growth rate (CAGR), standard deviation, and max drawdown numbers. The Coffeehouse Investor portfolio comes out ahead in this period with the highest annualized total return, second lowest standard deviation, and max drawdown.

Final Thoughts on The Coffeehouse Investor Portfolio

Most retirement plans have a mix of passive index funds and active funds. The Coffeehouse Investor Portfolio is one possible strategy assuming that all the asset classes are available as index funds. It is a no-brainer to use passive index funds for retirement portfolios in 401(k) plans or even IRAs. First, you will capture much of the market return and minimize costs. Next, the Coffeehouse portfolio keeps it simple but with better diversification lacking in some other popular lazy portfolios. Lastly, the Coffeehouse portfolio is easily implemented with ETFs or index funds from Vanguard, BlackRock, Schwab, or Fidelity.

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