Your portfolio strategy plays a major role in your ability to access gains in the stock market while limiting risk. However, new investors and those who lack extensive time for research may find it difficult to build a portfolio strategy of their own.
Don’t worry, you’re not alone.
The good news is that there are several prebuilt portfolios out there designed to simplify the investing process by providing an outline of how to go about asset allocation. One of the most popular of which is based on Jewish law and is known as the Talmud strategy.
What Is the Talmud Portfolio?
The Talmud strategy is based on Jewish civil and ceremonial law, known as the Talmud, which is where the portfolio gets its name. In the text of Rabbinic Judaism, the law is written as follows:
Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep by him in reserve.
Based on this law, the portfolio follows an asset allocation strategy that only includes those three asset classes: land, businesses, and cash — or modern-day renditions of them.
As a lazy portfolio, the strategy is centered around the buy-and-hold concept and is designed to be easy to set up and manage.
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Portfolio Asset Allocation
As mentioned above, the allocation within the portfolio is all geared toward three asset classes. These include:
- 33.4% in U.S. Stocks. One-third of the portfolio’s allocation should be invested in U.S. equities, reflecting the law’s outline of investing one-third of a person’s money in business. To gain this exposure, you’ll want to invest in an exchange-traded fund (ETF) that provides diversified exposure to the total United States market.
- 33.3% in Real Estate. The Talmud also stipulates that one-third of a person’s money should be invested in land. In the portfolio, that’s represented by diversified real estate investments through real estate investment trusts (REITs).
- 33.3% in Bonds. Finally, the law suggests keeping one-third of your money in a cash reserve. The best way to gain this exposure is by investing in fixed-income assets like Treasury debt securities and bond market investments, which act as a cash equivalent with some perks.
The Investment Thesis Behind the Portfolio
The portfolio was designed to line your investments up with Jewish beliefs. However, the thesis behind the investment goes far beyond that.
First and foremost, the ETFs used to gain exposure to stocks, real estate, and bonds are all highly diversified funds. Thanks to this portfolio diversification, those who take advantage of this investment strategy will be protected against significant market volatility.
Moreover, the strategy is built on the foundational work of Harry Markowitz, the father of the Modern Portfolio Theory. The theory suggests that a combination of volatile assets that are uncorrelated can be used to access higher returns while reducing drawdown risk.
Essentially, when one asset falls in value, other assets in the portfolio perform well, essentially offsetting much of the financial risk. Here’s how each asset class works in the portfolio:
Stocks tend to perform well when economic conditions are positive, leading to growth in corporate profits. During these times, the bond market isn’t always positive, but the outsize growth in stocks helps to outweigh the declines experienced in fixed-income assets.
Fixed-income assets have long been used as safe-haven investments that investors turn to when market and economic conditions turn for the worse. They tend to grow in value during economic contractions and bear markets, helping to offset the volatility of equity holdings.
Real estate tends to recover from bear markets before stocks. After all, when economic conditions are negative, the Federal Reserve enacts dovish monetary policy, leading to lower rates and more money being available for loans, spurring consumer spending.
While there’s usually a significant delay between when these changes happen and when the stock market recovers, the real estate market often recovers faster, leading to gains in this side of the portfolio and helping to offset bear markets as they come to an end.
Talmud Portfolio Pros and Cons
With any other prebuilt portfolio — or any other financial service, for that matter — you should thoughtfully consider the pros and cons before you dive in.
Talmud Portfolio Pros
There are several advantages to using this portfolio strategy, which is why it’s become so popular over the years. Some of the most significant advantages include:
- Compelling Returns. When backtesting this portfolio strategy, its performance throughout history has been compelling. While it’s not likely to beat widely accepted benchmarks in terms of raw returns, in terms of risk-adjusted returns using the Sharpe ratio, it has historically outperformed the S&P 500. That’s an impressive feat.
- Simplicity. In order to follow this portfolio, you’ll only need to invest in three investment-grade funds. That’s about as simple as a portfolio gets, making both setup and management a fast, easy process. Not to mention, as a buy-and-hold portfolio, regular maintenance is also fast and easy.
- Compliance with Jewish Law. For some investors, compliance with the laws of their religion is a must. The Jewish investing community can rest assured that when employing this strategy, your portfolio is in line with the laws of your faith.
Talmud Portfolio Cons
With strong returns, easy setup and management, and compliance with religious laws, it’s clear to see why so many are interested in this portfolio strategy. However, there are some significant drawbacks that should be considered before risking your hard-earned money:
- No Risk Premium Exposure. The fund doesn’t have any focus on factors that pay premiums like investing in small companies with value characteristics. That may prove to be a limitation with only one-third of the portfolio invested in equities. If you choose to follow this strategy, consider adjusting your stock holdings to tilt toward value factors.
- No International Exposure. The traditional build of the portfolio invests in a diversified fund holding U.S. stocks, but that doesn’t address the approximately 50% of the global market capitalization that exists in international markets. Without international exposure, there’s no way to profit from growth in businesses outside the United States.
Who Should Use the Talmud Portfolio?
As with any portfolio, the Talmud Portfolio wasn’t designed to be used by everyone. After all, your goals, time horizon, and financial capabilities will likely be far different from your neighbor’s.
The best candidates for this portfolio strategy are:
Investors of Jewish Faith
The Jewish tradition is imprinted in the name of this strategy, with its portfolio assets chosen specifically to match the requirements of the religion’s law. As a result, investors of Jewish faith will benefit greatly from this simple-to-follow portfolio strategy.
You don’t have to be a follower of any religion to use this strategy. In fact, it’s a great fit for many middle-aged investors because the risk level of its asset allocation is relatively moderate.
It’s not a good fit for younger investors with long-term time horizons who have the time to recover should a large drawdown take place in their portfolios. These investors should look for a portfolio that involves investing in higher-risk assets with the potential to beat average market returns.
On the other hand, it’s not a good option for older investors who are nearing or enjoying retirement. For these investors, stability is key, and any exposure to declines could damage all they’ve worked their entire lives to accomplish.
A middle-aged investor tends to be right in the middle in terms of risk and reward needs, which is where this portfolio leans.
How to Duplicate the Talmud Portfolio
The portfolio can be recreated by splitting your investment assets in thirds and investing each slice into a single diversified ETF. However, many investors will want to adjust the holdings in their portfolio to fit in with their investing styles. Both the traditional buildout and some of the most common adjustments are outlined below.
The Traditional Rendition
The traditional rendition of the portfolio can be put together by making equal investments in three investment-grade funds:
- Vanguard Total Stock Market Index Fund ETF (VTI). The VTI fund offers diversified exposure to the entire U.S. stock market. The fund invests in stocks of all market caps across all sectors and regions within the U.S.
- Vanguard Real Estate ETF (VNQ). The VNQ fund addresses the prescribed real estate allocation in the portfolio. The fund invests in REITs that purchase various forms of real estate including strip malls, cell towers, data centers, and more.
- Vanguard Total Bond Market Index Fund ETF (BND). Finally, the strategy calls for keeping one-third of your assets in cash or cash equivalents. The BND fund provides diversified exposure to the ultra-safe and highly liquid U.S. bond market, addressing the cash equivalent allocation within the portfolio.
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The International Rendition
There are several ways to adjust this portfolio strategy to fit your needs, and you can do so without breaking religious laws. One of the most common adjustments is to add an international spin to the portfolio’s holdings.
The first step is to cut the allocation to the VTI fund in half. Next, the remaining assets in your portfolio should be invested in the Vanguard Total International Stock Index Fund ETF (VXUS). As an ex-U.S. fund, this ETF invests in a diversified group of stocks around the world, excluding domestic companies. These include varying market caps, sectors, investing styles, and regions.
The Risk Premium Rendition
Another issue some may have with the portfolio is its broad exposure to the entire U.S. market. Many investors would rather focus their investment dollars on investments that are known to perform better than others.
For example, historically, value stocks have outperformed their growth counterparts over the long run. Small-cap stocks have paid a premium compared to larger stocks as well. Focusing on these factors has the potential to greatly expand your portfolio’s earnings, and considering the fact that only one-third of the portfolio is invested in stocks, doing so may be a wise decision.
To adjust the portfolio to offer a risk premium, simply replace the VTI fund with the Vanguard Small-Cap Value Index Fund ETF (VBR). The VBR fund consists of a diversified group of small domestic companies that come with value characteristics.
The Leveraged Rendition
Finally, some investors prefer the use of leverage to expand their gains in the market. Keep in mind, adding leverage is the riskiest rendition of this portfolio strategy and can significantly amplify drawdowns should a correction or bear market take place.
However, younger investors can benefit greatly from the introduction of leverage to this strategy if they want to follow the laws of their religion but still want to have access to increased earnings potential and are willing to accept increased risk.
To add leverage to the portfolio, swap the traditional holdings for the following:
- ProShares UltraPro S&P 500 (UPRO). The UPRO fund is a 3x leveraged S&P 500 fund. This means the fund uses leverage to amplify the gains or losses of the S&P 500 by three times.
- Direxion Daily MSCI Real Estate Bull 3X (DRN). The DRN fund covers the real estate side of the allocation, using leverage to generate three times the returns of the MSCI US IMI Real Estate 25/50 Index, which is a highly regarded representation of the investable real estate market in the U.S.
- Direxion Daily 7-10 Year Treasury Bull 3x (TYD). Finally, the TYD fund is aimed at tripling the returns of intermediate-term Treasury debt securities with average maturities from seven to 10 years, offering a bit of leverage on the cash exposure prescribed in the portfolio’s allocation.
Maintain Balance in Your Portfolio
As with any investment portfolio, it’s important to maintain balance among your investments. This particular strategy’s allocation isn’t just about balancing risk and reward — for many, it’s about following religious law, which only increases the need to keep everything in balance.
The problem is that over time, changes happen in financial assets. The goal is for all of the assets in the portfolio to grow, but even in times when they’re all going in the same direction, they will likely do so at a different pace. This means your portfolio will fall out of balance given enough time.
When this happens, your portfolio will be overexposed to some assets and underexposed to others, meaning that you’re either taking on excessive risk, or limiting your reward potential. This is when rebalancing comes in.
There are two pieces of good news here:
- It’s a Lazy Portfolio. Lazy portfolios are designed to require minimal work. It won’t require daily, weekly, or monthly rebalancing for most investors. You’ll generally only need to rebalance quarterly to keep it in line.
- There Are Only Three Assets. With only three assets to balance out, when it’s time to do so, rebalancing is as simple as dividing your total assets by three. When you come to your answer, that’s the amount of money that should be allocated to each asset in the portfolio. If that’s not the case, adjust as necessary.
There is one caveat to the rule. Those of the Jewish faith may want to take the time to rebalance their portfolios more often. The fact is that price movements happen by the second, and you will likely notice a slight imbalance at the close of each trading day. With rebalancing only taking a few minutes, it may be worth a small daily effort if you’re striving to maintain the portfolio’s balance for religious reasons.
The Talmud Portfolio is an interesting one. Not only is it the only prebuilt portfolio based on religious law, it’s surprisingly effective. There are few portfolio options that only invest one-third of their assets in equities, produce gains that are similar to the S&P 500, and beat the index in terms of risk-adjusted returns.
This portfolio is one of them.
Although that’s an impressive feat, and there are other reasons to consider using this strategy, there are also some drawbacks, most of which can be addressed with simple adjustments to the traditional portfolio’s holdings.
Nonetheless, when personalizing the portfolio, make sure you do your research and get a full understanding of exactly what you’re buying before you buy it.