Eliminate Fat Tails description

Mar 18, 2025 | 401Ks

Larry Swedroe Eliminate Fat Tails Portfolio: Overview

1. Background and Philosophy

The Larry Swedroe Eliminate Fat Tails Portfolio is designed by Larry Swedroe, a renowned financial author, researcher, and principal at Buckingham Strategic Wealth. Swedroe is a proponent of evidence-based investing, emphasizing low-cost, passive strategies that minimize risk and maximize long-term returns. This portfolio reflects his focus on reducing tail risk (extreme market downturns) by combining equities with high-quality bonds and inflation-protected securities.

2. Asset Allocation Analysis

The portfolio is structured as follows:

  • 15% EEM (iShares MSCI Emerging Markets ETF): Provides exposure to emerging market equities, offering growth potential but higher volatility.
  • 15% IJR (iShares Core S&P Small-Cap ETF): Focuses on U.S. small-cap stocks, which historically outperform large caps over long periods but are riskier.
  • 35% BIL (SPDR Bloomberg 1-3 Month T-Bill ETF): Allocates to ultra-short-term Treasury bills, providing liquidity and stability.
  • 35% TIP (iShares TIPS Bond ETF): Invests in Treasury Inflation-Protected Securities (TIPS), hedging against inflation.

Diversification and Risk

The portfolio is highly diversified across equities (U.S. small caps and emerging markets) and bonds (short-term Treasuries and TIPS). However, its risk level is moderate to high due to the significant equity exposure (30%) and the volatility of small-cap and emerging market stocks. The bond allocation (70%) mitigates some risk but leans toward shorter durations, which may underperform in falling rate environments.

Pros and Cons

Pros:

  • Inflation protection via TIPS.
  • Low correlation between asset classes reduces tail risk.
  • Low-cost ETFs align with passive investing principles.

Cons:

  • Limited growth potential due to heavy bond allocation.
  • Emerging market and small-cap risks can lead to volatility.
  • No exposure to large-cap U.S. or international developed markets, which may limit diversification.

3. Practical Application in Retirement Accounts

For 401(k) Accounts:

Investors should:

  1. Identify comparable funds in their 401(k) plan:
    • Replace EEM with an emerging markets stock fund or a broad international equity fund.
    • Replace IJR with a U.S. small-cap index fund or a Russell 2000 fund.
    • Replace BIL with a short-term bond fund or money market fund.
    • Replace TIP with a TIPS fund or inflation-protected bond fund.
  2. If a specific holding is unavailable, allocate to the closest broader asset class (e.g., substitute missing TIPS with a total bond market fund).
  3. Since commodities are rare in 401(k)s, any such allocation should be redirected to stocks or bonds.

For IRA Accounts:

Investors can directly purchase the ETFs listed in the portfolio, as IRAs offer greater flexibility. Rebalance annually to maintain the target allocations.