Why Does Everybody Recommend Complex Portfolios?

A reader writes in, asking

“On the Bogleheads forum I see people recommending the ‘three fund portfolio’ with Total Stock Market, Total International Stock, and Total Bond Market funds. But I never see something this basic anywhere else. Elsewhere, I see portfolios recommended that include many more funds or articles recommending the new and improved types of index funds. What’s wrong with a normal index fund portfolio? Why doesn’t the three fund portfolio or anything similar get talked about anywhere else?”

To understand this phenomenon, I think it’s helpful to step back and look at an industry trend: Over the last several years, the idea that passive investing is generally preferable to active investing has become the conventional wisdom. Evidence of this trend is all over the place — the massive size of Vanguard, the explosive growth of assets invested in ETFs, or the steadily-rising percentage of equity mutual fund assets that are invested in index funds.

But that new conventional wisdom presents a challenge for many parties: How do we make money?

Mutual fund companies are unlikely to beat Vanguard at their own game. (And most fund companies wouldn’t even want to — there’s not a lot of money to be made by being the rock-bottom-cost provider of a commodity service.) So they need something to sell you other than your basic market-weighted index fund. But they still want to fall under the “passive” umbrella so that they can get all the marketing benefits of being associated with the passive-beats-active conventional wisdom. So now rather than fund companies pushing their actively managed funds, we see many pushing a new breed of fancy-passive funds: smart beta, equal-weight index funds, fundamental index funds, and so on.

And advisors who practice only portfolio management (rather than broader financial planning) have a similar predicament. Passive portfolio management is already available at a very low cost via all-in-one funds (e.g., Vanguard Target Retirement Funds) or via a “robo-advisor” such as Betterment or Wealthfront. Advisors can’t beat those services on cost, so they have to show that they can do something better. In most cases, that means trying to convince you that the portfolio that they will craft for you is better than the portfolio you’d get via one of those less expensive options. And it’s easier to convince you of that if they recommend something that looks very sophisticated.

Now, to be clear, writers (myself included) are faced with the same dilemma. There isn’t that much to say about a boring market-weighted portfolio made of just a few index funds. And there’s even less to say about a portfolio consisting of nothing but an all-in-one fund. And yet we need topics for articles. So you’ll find us writing about a whole list of other investment strategies.

In other words, at least a part of the reason why simple portfolios using traditional index funds don’t get a great deal of discussion is that, in many cases, it’s more profitable to talk about something else.