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Coffeehouse Investor Portfolio – Guide to Asset Allocations, Pros & Cons

Many people perceive the stock market as a complex system in which only the professionals have any chance of making real money. Yes, the market is a complex system, but believe it or not, you don’t have to be an expert to use it successfully as a machine to build your wealth.

There are several prebuilt investment portfolios available that are designed to give you safe access to the wealth-building power of the market, regardless of your expertise as an investor.

One such prebuilt portfolio is known as the Coffeehouse Portfolio. The portfolio is centered around the idea that investing shouldn’t take a rocket scientist working a full-time job to be successful. Instead, the inventor of the portfolio suggests it’s so simple to set up and manage that it can be done in a few minutes while sipping your coffee at the local coffeehouse.

What Is the Coffeehouse Portfolio?

The portfolio was developed by Bill Schultheis, a financial advisor at Soundmark Wealth Management and author of the book “The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get on with Your Life.”

Beyond the strategy, the book is a great read jam-packed with information to help you better understand the market and what building wealth is all about.

Schultheis has long been a proponent of a class of portfolios known as lazy portfolios, the buy-and-hold style portfolio that doesn’t require much management. So, it only makes sense that his Coffeehouse Portfolio follows along the same lines.

At its core, the portfolio follows a 60/40 allocation strategy, investing 60% of the portfolio in stocks to capture market growth and 40% of the portfolio in bonds to balance out risk. The portfolio gives heavy emphasis to small-cap and value stocks. Here’s how the asset allocation works:

Portfolio Asset Allocation

The portfolio follows a 60/40 model that uses a range of asset classes specifically chosen to provide access to some of the largest opportunities for growth while balancing risk in the portfolio. Here’s how the core allocation looks:

  • 10% in Large-Cap Stocks. The first 10% of the allocation should be aimed at large-cap United States-based companies. To gain diversified exposure to this area of the market, it’s best to invest in a domestic investment-grade fund with a low expense ratio and a focus on investing in companies with large market caps across a wide range of sectors.
  • 10% in Small-Cap Stocks. The next 10% of the allocation will go to U.S.-based companies with small market caps. Again, make sure to choose a fund that diversifies across various sectors within the United States market and offers a low expense ratio.
  • 10% in Large-Cap Value Stocks. Next up, the heavy value weighting in the portfolio starts. 10% of your portfolio should be invested in a fund that focuses on large companies that display value characteristics across a wide range of sectors.
  • 10% in Small-Cap Value Stocks. Another 10% of the asset allocation will be aimed at value with a fund focused on investments in smaller companies that come with value characteristics, suggesting they’re undervalued.
  • 10% in Real Estate Investment Trusts (REITs). Next, 10% of the portfolio should be invested in real estate investment trusts (REITs), providing exposure to the real estate market.
  • 10% in International Stocks. Another 10% should be invested in a heavily diversified international fund. The fund should focus on both developed and emerging markets while diversifying across different sectors and market caps.
  • 40% in Bonds. Finally, 40% of the portfolio should be invested in a fund focused on fixed-income investments. Preferably, this would be a low-cost bond fund with an intermediate term.

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The Investment Thesis Behind the Portfolio

The investment thesis behind the portfolio is relatively simple. It was designed to give investors access to the gains the stock market has to provide while leveling risk out with a heavy allocation to fixed income.

However, in an attempt to offset the limited earning potential of the heavy bond allocation, the portfolio includes aggressive investments aimed at significant growth.

In particular, you’ll notice that the portfolio allocates one-third of its stock investments to value stocks, both large- and small-cap. Historically, over long enough time horizons, value investing has outperformed both growth and income, offering a long-term opportunity to generate significant gains.

Taking that one step further, half of the value allocation is focused on companies with small market capitalizations. Stocks in this category have historically outperformed their larger counterparts, but come with increased risk.

The portfolio also invests 10% of its allocation in emerging markets, which also have the potential to outperform U.S. stocks. However, as with any investment that comes with increased growth potential, drawdown risks are increased.

Of course, there’s also the heavy allocation of bonds, which is part of the portfolio for good reason. During bear markets and market corrections, stocks across the market will experience declines. However, the stability offered up by these bonds helps to reduce exposure to this volatility.


Pros and Cons of the Coffeehouse Portfolio

The Coffeehouse Portfolio has become a popular option among the investing community, giving investors a largely set-it-and-forget-it way to get involved in the market. While there are clear perks to this portfolio strategy, there are also some drawbacks you should consider before diving in.

Coffeehouse Portfolio Pros

There are several reasons Coffeehouse investors are happy with the portfolio. Some of the most significant include:

  1. Reasonable Portfolio Returns. Most 60/40 portfolios have relatively modest returns. The heavy allocation to fixed-income securities limits the earnings potential. However, in this case, the limited earnings potential is mostly offset by investments in value, small-cap, and international stocks. While you’re not likely to beat the returns of the S&P 500, the portfolio will generally come close to these returns while offering protection against significant declines.
  2. Value Weighted. The portfolio is heavily weighted toward value stocks, which have historically outperformed income and growth stocks. After all, if buying low and selling high is the goal, why not buy at a discount?
  3. Limited Work Required. Setting up and managing this portfolio is extremely simple. As a buy-and-hold portfolio, you won’t need to rebalance as often as you would need to with a more active strategy. Choosing the exchange-traded funds (ETFs) you invest in is the hardest part of the process.

Coffeehouse Portfolio Cons

There’s plenty to like about this strategy, but every rose does have its thorns, and in some instances, coffee can burn. Here are the drawbacks to following this strategy:

  1. Heavy Bond Allocation. While the heavy allocation of bonds is somewhat offset by value investments, it’s still largely limiting in terms of portfolio returns. As a result, if your goal is to beat overall market performance, you’ll want to look to another strategy.
  2. Limited Emerging Markets Exposure. Only about 10% of the portfolio is focused on international investments. This could prove to be a mistake. While these markets are risky, they’re also home to some of the largest opportunities for growth.

Who Should Use the Coffeehouse Portfolio?

As with any other portfolio strategy, the Coffeehouse Portfolio isn’t a one-size-fits-all approach to investing. Investors who would benefit most from a strategy like this include:

Value Investors

Value investors are focused on buying assets that are trading at a discount compared to their peers and holding those assets until they climb to fair market value, making a profit in the process.

The Coffeehouse strategy involves offsetting heavy investments in fixed-income securities with heavy stock allocation to value plays, making it an attractive choice among value investors looking to limit risk.

Middle-Aged Investors

With such a heavy allocation to bonds, the portfolio isn’t a great fit for young investors who can absorb more risk and have time to recover from declines in the market.

On the other hand, it’s still a bit aggressive for those either nearing retirement or in their golden years — there is still moderate drawdown risk, and these investors won’t have the time to recover from declines.

The sweet spot is investors aged 35 to 50.

These investors don’t want to accept too much risk, but should still expose their portfolio to moderate risk in an attempt to generate growth, making the Coffeehouse strategy a perfect fit.


How to Duplicate the Coffeehouse Portfolio

There’s no single specified Coffeehouse Portfolio. Instead, the portfolio strategy is more of an allocation guide. Therefore, there are no specific ETFs or index funds that you need to buy to take advantage of the portfolio.

Provided below are some examples of low-cost funds that fill the criteria the portfolio strategy lays out — and some alternatives you can use to customize the model to suit your investing preferences and risk tolerance.

The Traditional Coffeehouse Portfolio

If you’re interested in taking advantage of the core Coffeehouse strategy, you can do so by using the following low-cost funds:

  • 10% in Vanguard Large-Cap Index Fund ETF (VV). The VV offers diversified access to large companies in the United States. The fund invests in large United States companies ranging in sectors.
  • 10% in Vanguard Small-Cap Index Fund ETF (VB). Next up is the VB, which offers diversified exposure to small companies across the United States. As is the case with the VV, the companies the fund invests in operate across varying sectors.
  • 10% in Vanguard Value Index Fund ETF (VTV). The VTV invests in large United States-based companies with value metrics that suggest they are trading at a discount.
  • 10% in Vanguard Small-Cap Value Index Fund ETF (VBR). Next up, the VBR invests in a long list of smaller companies that display strong value characteristics.
  • 10% in Vanguard Real Estate Index Fund ETF (VNQ). The VNQ invests in a diversified portfolio of REITs. These are companies that purchase various types of real estate and make money leasing their properties across the United States.
  • 10% in Vanguard Total International Stock Index Fund ETF (VXUS). The VXUS represents the international investment allocation in the portfolio. The fund invests in a diversified list of companies outside of the United States. These investments span various regions, from emerging to developed, as well as multiple sectors and market caps.
  • 40% in Vanguard Total Bond Market Index Fund (VBMFX). Finally, 40% of the portfolio is allocated to the VBMFX, a diversified bond fund that gives investors exposure to investment-grade bonds, both U.S. Treasury debt securities and corporate bonds, with ranging maturities.

Pro tip: You don’t have to take the time to choose the exact funds you want to invest in and build the portfolio for yourself from scratch. You can use M1 Finance and add the prebuilt expert pie for the Coffeehouse Portfolio to instantly gain access to a portfolio that follows this investing model.

The International Coffeehouse Portfolio

Some argue that the limited exposure to international stocks in the traditional Coffeehouse Portfolio limits your potential returns. If you’re interested in taking a more international approach, there are a few changes you’ll want to make.

To allow for greater allocation to international stocks, you can cut exposure to the VB, VTV, and VBR funds to 5% of the portfolio each (15% total). Your 10% allocations each in the VV, VXUS, VNQ funds remain unchanged (30% total).

On the bond side, you can completely replace the allocation to the VBMFX fund with an equivalent, internationally focused bond fund.

To fill in the holes left by the allocation changes, you’ll want to make the following additions:

  • 5% Vanguard FTSE All-World ex-US Small-Cap Index Fund ETF (VSS). The VSS fund invests in a diversified group of small-cap stocks from various regions around the world, in both emerging and developed economies. The investments also spread across all sectors of the market.
  • 5% Vanguard FTSE All-World ex-US Index Fund ETF (VEU). The VEU fund invests in a diversified group of medium-sized and large companies in markets outside the United States. Investments range across regions and sectors.
  • 5% WisdomTree International SmallCap Dividend Fund (DLS). The DLS fund invests in a diversified global group of small companies that are known for paying compelling dividends. Specifically, the fund invests in companies in developed nations outside of the U.S. and Canada.
  • 40% Vanguard Total World Bond ETF (BNDW). Finally, the BNDW fund provides diversified exposure to the global bond market. Weighted heavily toward intermediate-maturity dates, the fund also has some investments in short- and long-term bonds.

The Domestic Coffeehouse Portfolio

While some investors would prefer a larger allocation to the international category, other investors prefer keeping their investment dollars domestic. If you’d like to do so, you won’t need to make too many adjustments to the traditional portfolio.

To eliminate your international exposure, simply split the 10% allocation in the VXUS international stock fund called for in the traditional Coffeehouse Portfolio between the VV and VB funds to gain greater exposure to both small- and large-cap domestic stocks.

Once this change is made, each of these two investments will represent 15% of your total portfolio allocation.


Keep Your Portfolio Balanced

Investment portfolios are thoughtfully designed to balance potential risk versus reward. Fixed-income balances equities, large-cap balances small-cap, and domestic equities balance international investments.

As your investments mature, some will grow at faster rates than others. In fact, a properly balanced portfolio will have various assets with inverse relationships, meaning that some will gain when others fall and vice versa. As a result, your portfolio will eventually fall out of balance.

That’s why rebalancing is so important.

If your portfolio is too out of balance, it will either limit your exposure to profitable opportunities or increase your exposure to risk.

The good news is that this portfolio is a lazy portfolio, meaning you won’t have to rebalance on a weekly or even monthly basis. However, quarterly rebalancing will help ensure that your investments stay in line with your portfolio strategy.


Final Word

All told, the Coffeehouse Portfolio is a great option for a large group of investors — specifically middle-aged investors with an eye for value opportunities.

As with many other portfolios, the Coffeehouse strategy isn’t set in stone. It’s meant to be a guide. Using the strategy as a base point and customizing it to fit your needs is a relatively simple process, as you can see in the international and domestic examples above.

With a little creative thinking and market research, you may find the portfolio is a great guide to setting up your own unique rendition of a balanced, hands-off portfolio.

Joshua Rodriguez
Joshua Rodriguez has worked in the finance and investing industry for more than a decade. In 2012, he decided he was ready to break free from the 9 to 5 rat race. By 2013, he became his own boss and hasn’t looked back since. Today, Joshua enjoys sharing his experience and expertise with up and comers to help enrich the financial lives of the masses rather than fuel the ongoing economic divide. When he’s not writing, helping up and comers in the freelance industry, and making his own investments and wise financial decisions, Joshua enjoys spending time with his wife, son, daughter, and eight large breed dogs. See what Joshua is up to by following his Twitter or contact him through his website, CNA Finance.

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