Can Investing Be Too Simple?

One of the most popular quotes attributed to Albert Einstein is "Everything should be made as simple as possible, but not simpler." Many investors take this advice and apply it to the building of portfolios. Is that a good idea?

Equities
For your equity investments, you can keep it as simple as possible by purchasing an S&P 500 Index fund or a U.S. total market fund. However, you can improve on that most simplistic of portfolios by adding exposure to international equities, such as through an MSCI EAFE Index fund. That strategy has produced more efficient portfolios, thanks to diversification of risk. And one could add a bit more complexity by adding an allocation to the MSCI Emerging Markets Index. Once again, that would have produced more efficient results.

Another way to improve expected results is through adding allocations to small-cap and value stocks, both domestically and internationally. Such portfolios, with disciplined rebalancing, have produced even more efficient results.

Thus, while still keeping it simple -- investing in a small number of index or passively managed funds -- investors have been rewarded for adding a bit of complexity on the equity side of the balance sheet.

Fixed Income
The bond side of the balance sheet presents a different tale. The historical evidence is that you have been best rewarded by keeping it as simple as possible, investing only in Treasury bonds, either nominal return bonds or TIPS. (At least, this is true for tax-advantaged accounts. If you need to hold bonds in taxable accounts, municipal bonds rated AAA or AA are all that are needed.)

The evidence is that adding complexity, in the form of mortgage-backed securities or credit risk, hasn't been rewarded in the form of more efficient portfolios.

Keeping it simple is generally good advice. However, keeping it as simple as possible may not be.