An Allocation Hypothesis for Investors Who Want Long-Term Wealth Without Pretending Valuations Don’t Matter
By: Scott Trench
I’ve long believed the simplest, most effective wealth-building strategy for most people is a basic total-market allocation, and often put most of my own wealth in vanguard’s low-cost total market index fund ETFs. This strategy has created enormous wealth for me and millions of others with minimal complexity.
But “simple” doesn’t mean “ignore reality,” and this thesis attempts to explore a challenge that many investors are grappling with: Right now the U.S. stock market demands a level of optimism that is hard to fathom for value-oriented investors like myself, who both believe in passive investing, but also believe that price does, at some point, matter.
Here are some valuation ratios that give investors like me real reason to worry about the forward returns of my favorite investment – passive ownership of the S&P 500:
- Shiller CAPE near 39 (long-term average is ~17)
- Buffet Indicator: Market cap to GDP above 200% (long-term range is ~80%-90%)
- Forward P/E for the largest companies in the high 30s
- 38% of the S&P 500 concentrated in 10 stocks
- S&P 500 Price to Sales Ratio of 3.42 (highest in history, exceeds dot-com peak of 2.36).
I also want to observe that S&P 500 companies, notably big tech, invested an estimated $400-$430B in AI in 2025. Much of this investment is “Capitalized” – meaning it is treated as an asset that will generate returns into the future. But, I believe AI will not work like a traditional asset. I believe that AI investment becomes functionally obsolete in a matter of 1-2 years, if not on a rolling 6 month basis, as chips get exponentially faster. This $400-$430B “investment” is much more like an “expense” that will have to be paid for every year, in escalating fashion, until the arms race ends.
These don’t guarantee a crash. I am not predicting a crash.
I also exited portions of my stock portfolio in February of 2025, in part due to similar high earnings fears, and my redeployment likely cost me ~5-6% in terms of opportunity cost over the course of 2025, after factoring in estimated returns from the real estate I bought and the larger cash position I maintained with the proceeds. These same ratios were well beyond historical norms last year, and they could well continue to rise even further in 2026.
And, there are reasons why long-term historical averages across many of these ratios are not fair or useful. For example, interest rates were much higher than current rates for much of history, and globalization is a major part of the reason why certain mega-cap stocks with worldwide reach help stretch valuations to greater than the output of the U.S. economy on it’s own.
Again, I am not predicting a crash.
But, I am saying that valuations are so high that the implied 10-12 year forward return on the S&P 500 is now so low, unless this time is different, that I am asking the question:
“Is there a higher earning yield, lower volatility place to park capital while I wait for the S&P’s earnings to catch up, or the price to fall? Can I invest in a portfolio that I can hold in perpetuity, only lagging moderately behind the S&P 500’s historical returns if the S&P 500 never again is priced at a level that I can comprehend?”
Let me be very clear, as I get into this – this portfolio is a thought experiment only. It is a test I am developing, against other more traditional portfolios. It is an actively managed portfolio, and I do not suggest that others invest in this portfolio, or the specific ETFs I mention here.
My starting hypothesis for this portfolio looks like this:
- 30% BND
- 20% VNQ
- 30% AVUV
- 20% AVDV
It’s a portfolio built around three principles:
- Paying a reasonable price matters.
- Price to earnings is the best way to determine a “reasonable price”.
- Keeping the portfolio simple, liquid, and rule-based to allow me to return to passive index ownership of the S&P 500 when it is priced at levels I think are fair.
Why These Four Funds Today
1. Bonds (BND) Reasonable Yield + “Insurance” for Re-Entry
Are bonds perfect crash insurance? No. But, they do generate a 4.7% SEC yield as of Dec 1 2025 with a weighted average duration of 6%, and this is a set of pre-committed capital that will be redeployed into the S&P 500 if and when valuations return to “reasonable” (Shiller CAPE ≤ 25).
This is not a permanent bond allocation. It is insurance, with real risk in rising interest rate environment, yielding 4.7%, to be used if prices return to normal. I can hold it indefinitely, or move into equities when they get to a place I can understand once again.
There is also real risk associated with this position – if rates rise, this position will suffer at least modest losses in nominal terms, and in the face of high inflation, higher losses in real terms.
2. REITs (VNQ) Real Estate Dampens Volatility and Produces High Yield
REIT prices have gone basically nowhere over the past 5 years, as an asset class particularly sensitive to interest rates. They are about half as expensive, per dollar of earnings, as the S&P 500. While there are plenty of risks, I believe REITs to be less risky than the S&P 500 at this time.
Trading near 0.75× book value. Forward FFO multiples near recession-era lows (Estimated 16X forward FFO, vs 27X S&P 500 price to earnings – VNQ’s 20-year average is closer to 17-19X).
An additional benefit is the strong negative correlation with the Magnificent 7. This position is both providing a strong starting yield, and dampens volatility on what is otherwise a heavily weighted value-stock portfolio.
A drawback, however, is that, if interest rates rise, real estate could face further challenges, as REITs struggle to refinance debt, and see cap rates expand (valuation decline).
3. U.S. Small-Cap Value (AVUV) Fairly Priced Relative to History
Most of the S&P 500 today is priced like a momentum trade, not a business purchase. In contrast, U.S. small-value stocks are trading on low P/B, low P/S, real earnings, real cash flow, real profitability, and sensible multiples relative to history. Currently trading at 11.2 Forward Price to Earnings, much lower than the S&P 500, and lower than it’s historical median (~13-14x).
When I think about owning a slice of businesses, AVUV looks a lot more like the kind of company I’d buy privately. The king of stuff that is profitable, boring, underfollowed, and cheap.
4. International Developed Value (AVDV) A Hedge Against U.S. Overconcentration
This is the international equivalent of AVUV, trading at 12X trailing Price to Earnings. The idea is that International stocks are cheap for both cyclical and structural reasons: aging demographics, conservative capital allocation, slower innovation, historically lower margins.
While international developed markets face headwinds too, AVDV offers a much higher earnings yield (~8.5%) than U.S. large caps (~2.5%).
So What Is This Portfolio, Really?
This is not a “permanent portfolio.” This is not short-term market timing. This is not an emotional flight from equities. It is “Actively Managed”. It does violate core boglehead investing principles and principles espoused in The Simple Path to Wealth.
This is a cash-flow-forward allocation designed for to help me hypothesize how to continue to invest as someone who believes in long-term stock ownership, but who also believes that price matters. The idea is to question if this is the place to wait, indefinitely, if needed, for the S&P 500 to be priced in some kind of historically “normal” context.
Across the four components, the portfolio’s earnings yield is ~7.0%-7.5%, vs ~2.7% for the S&P 500, meaning that long-term returns have a much stronger starting point, even if all sectors maintain their current relative valuations.
This portfolio is, however, vulnerable to underperforming if U.S. multiples stay permanently high in the growth sector in particular, or earnings growth continues at very high levels for many years, and is vulnerable if interest rates rise in a low inflation environment. This time could be different and AI could change things permanently. Value stocks, bonds, and real estate can and have underperformed for long periods. A risk that I am taking with this portfolio.
Current expected portfolio yield (as of December 2025): approximately 4.0%. The tax implications can be offset with portions of the portfolio being held in tax-advantaged retirement accounts, but this test account will bear the full tax burden.
This portfolio should generate ~4% current income, exhibit dramatically lower volatility than the broad market in the exact scenario that worries me most (higher real rates or a growth-stock repricing), and contains pre-committed capital (the BND sleeve) that will automatically buy broad U.S. equities if they ever become cheap again.
The Re-Entry Plan:
I’m not predicting when valuations normalize. This is just my view on what “reasonable” looks like:
Phase 1: When Shiller CAPE ≤ 25, Move 30% of the portfolio (BND Sleeve) into VOO or VTI.
Phase 2: When any one of the following occurs in addition to Phase 1:
- Shiller CAPE falls below ≤ 20
- Buffet Indicator (S&P 500 Market cap to GDP < 125%
- S&P 500 price-to-sales ≤ 1.7×
Move the remaining 70% into VOO and resume passive index fund investing.
The 30% currently in BND is the first tranche of capital that will fund these purchases. The “insurance” will be cashed in if and when the market ever presents itself as “fairly valued” in my view.
These thresholds are not extreme. They don’t require a 50% crash and can attained by earnings growing, not just prices coming down. They simply move the U.S. market back toward its long-term historical relationship to earnings, sales, and GDP.
Why This Works Emotionally for Me:
The biggest risk in a high-valuation market is behavioral: buying late, selling low, abandoning your plan, or sitting in cash indefinitely. By pre-committing to these thresholds, the structure eliminates a behavioral trap of waiting for the perfect moment.
This portfolio solves those problems. It yields ~4% from day one. It’s diversified across four very different sources of return. It avoids concentration risk. It gives me a clear roadmap back into broad equities.
I’m not speculating. But, I am responding to a pricing situation in the S&P 500 that I don’t understand and am not comfortable with.
Final Thoughts
My position with this portfolio can be summed up as: “I want to own the S&P 500 long-term, but I’m not comfortable buying it at one of the most expensive valuations in history.”
This allocation is not a rejection of passive investing. It is a commitment to owning U.S. equities at prices that make sense. Until then, it’s a disciplined, high-yielding, lower-volatility place to wait, with a transparent and unemotional roadmap back into broad U.S. exposure.
Now, let’s see how it performs against the more boring, tested portfolios I built today in:
- 100% VOO
- 60% VOO, 40% BND
- Risk Parity
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