Select the asset allocation mixture on your investments carefully prior to investing. This means understanding the risks that are involved (primarily market risk and inflation risk). Educate yourself on the matter through independent experts who teach instead of sell. Once you know what the right allocation is for you (this can and usually does change over time as you age and get closer to withdrawing money), set it and leave the damn thing alone. With that said, you will want to answer the questions below.
Read All About Asset Allocation, by Rick Ferri. This book will provide you a good foundation of knowledge that will help you with this very important decision. Asset allocation is a pretty simple concept, once you become educated on the matter and understand how to separate your investments in a cohesive and understandable way. Your asset allocation should work hand-in-hand with your financial plan that contains your short- and long-term goals. Vast diversification at the lowest possible cost is the goal using a passive approach with index funds or ETFs. YOU can do it!
John Bogle, author of The Little Book of Common Sense Investing and Common Sense on Mutual Funds provides a simple approach to this issue. Use your age to identify what your bonds and cash allocation should be. If you were 35, you would have 35% of your investments in bonds and cash and 65% of your investments in stocks. This seems a bit too bond heavy to me, but Mr. Bogle was a very wise and experienced man. He would admit that this is a pretty conservative allocation, but he would also tell you that many people are not as risk averse as they think. Know thyself!
Read The Four Pillars of Investing, 2nd Edition by William Bernstein. This book is for the person who has read many books on investing and is ready to learn at a deeper level. Bernstein does a beautiful job of helping you understand the theory behind investing, the history of markets, the pychology that is involved and finally, how the financial services industry works. When you are done with this book, your level of knowledge will far surpass the vast majority of investors, to include the folks who work in the industry. The Investor's Manifesto is a condensed version of this book if you prefer that simpler option.
Once you have selected your asset allocation, place that money in no-load index mutual funds. You can find a list of recommended funds on this website. Once you become truly educated on investing and discard your ego, you will see the wisdom of investing in these types of funds that diversify you all over the world at the lowest possible cost. Could you do it with ETFs? Sure, but the goal is to buy and hold and for many, ETFs cause more buying and selling. I prefer a few index funds as you automatically reinvest the yearly income. Keep it simple.
Purchase your funds, allocate them appropriately, (diversified all over the world) and then leave them alone. Leaving them alone is very, very important. BUY AND HOLD works. Your asset allocation model is not to be touched until it is time to rebalance them and that should not happen very often. This means no timing the market. No listening to the TV pundits. And, definitely don’t listen to Billy Bob in the break room at work. None of the advice these “experts” spew out is worth a hill of beans. Stick to your plan and stay the course!
Rebalance your investments either once a year or because one or more assets have exceeded their threshold (a 80% stock allocation has reached 90% for example). This means you sell some winners and buy some losers to get you back to your designated allocations. You can also do this by simply adding more money to different accounts throughout the year. If you are in the withdrawal stage, you can rebalance by selling your winners. Do not rebalance in non-retirement accounts unless tax harvesting or capturing a gain makes sense. IRA's are good places to rebalance.
Here is an example using a $300,000 Portfolio with a desired asset allocation of 90%, 80%, 70%, or 60% in stocks. You would want to keep the Real Estate, Small-Cap Value, small international and Bonds (if possible after age 59.5) in retirement accounts because they are not tax efficient (tax efficiency = low turnover and minimal yearly income to include capital gains). The other funds could be kept in a non-retirement brokerage and/or a retirement account because they are more tax efficient. The goal is to be efficient with your allocations, fees, and taxes all along the way.
If you are going to use factors, there is a simple way to focus on the market, value, size, quality, term and momentum factors. Keep most of your equities in total market funds like VTSAX, VTIAX, VEMAX, and/or VTMGX. Overweight the portfolio with small/value companies by owning VSIAX. Capture the quality/term factor by owning VBTLX and VBIRX. Finally, capture the momentum factor by simply minimizing how often you tinker with the portfolio to include rebalancing. This means rebalancing only at thresholds, like 10% above or below the desired amounts.
In the examples below, you could consider some modifications to suit your situation and preferences. For example, you could go real simple by sticking with VTSAX as your only stock fund and VBTLX or VBIRX as your only bond fund. You could also add VTIAX to hold developed/emerging stocks (75/25 split approximately) rather than owning them separately. You could hold less than 30% in international stocks or more based on your preferences. You could hold VMFXX (federal money market at Vanguard in the settlement fund) for your cash now that it is paying over 5%.
You could reduce or increase the percentages per asset class or fund. The 20% allocation to VSIAX is there to offset the heavy weighting to large growth within VTSAX. You might find that to be about right or too little or too much. You could add VIOV instead of or with VSIAX to capture more small-cap value exposure. Try not to get the situation "perfect." Perfect can only be known looking back in time. Get your plan put together based on what we know about markets, history, reversion to the mean, recency bias, etc.and then allocate appropriately.
Asset allocation can also play a part to play when deciding what accounts to hold what funds. VTSAX is a good fund to hold in a brokerage or retirement accounts. VTIAX also works well with both. Bond index funds, real estate, small-cap value, and small international tend to be not tax efficient so that means they belong in retirement accounts like IRAs, 401(k)s, 403(b), etc. Sometimes you are forced to hold a bond index in a brokerage because that is your emergency account. So be it, but when you hit 59.5, consider holding your bonds in your Traditional IRA.
90% stock allocation
Stocks = $270,000 = 90% of the portfolio
40% / Total Stock Market Index Fund (VTSAX) = $108,000 at .04% expense ratio (owns primarily large growth companies in the US)
20% / Small-Cap Value Index Fund (VSIAX) = $54,000 at .07% expense ratio (adds more small and mid size, value oriented companies in the US)
10% / Developed Markets Index Fund (VTMGX) = $27,000 at .07% expense ratio (owns large companies in developed nations outside the US)
10% / Emerging Markets Stock Index Fund (VEMAX) = $27,000 at .14% expense ratio (owns large companies in emerging nations outside the US)
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $27,000 at .17% expense ratio (owns small companies outside the US)
10% / Real Estate Index Fund (VGSLX) = $27,000 at .12% expense ratio (adds more exposure to commercial real estate in the US)
Bonds = $30,000 = 10% of the portfolio
50% / Total Bond Market Index Fund (VBTLX) = $15,000 at .05% expense ratio (owns high quality intermediate-term bonds in the US)
50% / Short-Term Bond Index Fund (VBIRX) = $15,000 at 07% expense ratio (owns high quality short-term bonds in the US, use as cash equivalent)
OR you could put 100% of your bonds in the Intermediate-Term Tax Exempt Fund (VWIUX) if you are in a high federal tax bracket (32% or higher)
OR you could put 50% or more of your fixed income portfolio (bonds and cash) in VMFXX when cash is paying more than 4%
80% stock allocation
Stocks = $240,000 = 80% of the portfolio
40% / Total Stock Market Index Fund (VTSAX) = $96,000 at .04% expense ratio
20% / Small-Cap Value Index Fund (VSIAX) = $48,000 at .07% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $24,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $24,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $24,000 at .17% expense ratio
10% / Real Estate Index Fund (VGSLX) = $24,000 at .12% expense ratio
Bonds = $60,000 = 20% of the portfolio
50% / Total Bond Market Index Fund (VBTLX) = $30,000 at .05% expense ratio
50% / Short-Term Bond Index Fund (VBIRX) = $30,000 at 07% expense ratio
70% stock allocation
Stocks = $210,000 = 70% of the portfolio
40% / Total Stock Market Index Fund (VTSAX) = $84,000 at .04% expense ratio
20% / Small-Cap Value Index Fund (VSIAX) = $42,000 at .07% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $21,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $21,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $21,000 at .17% expense ratio
10% / Real Estate Index Fund (VGSAX) = $21,000 at .12% expense ratio
Bonds = $90,000 = 30% of the portfolio
50% / Total Bond Market Index Fund (VBTLX) = $45,000 at .05% expense ratio
50% / Short-Term Bond Index Fund (VBIRX) = $45,000 at 07% expense ratio
60% stock allocation
Stocks = $180,000 = 60% of the portfolio
40% / Total Stock Market Index Fund (VTSAX) = $72,000 at .04% expense ratio
20% / Small-Cap Value Index Fund (VSIAX) = $36,000 at .07% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $18,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $18,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $18,000 at .17% expense ratio
10% / Real Estate Index Fund (VGSAX) = $18,000 at .12% expense ratio
Bonds = $120,000 = 40% of the portfolio
50% / Total Bond Market Index Fund (VBTLX) = $60,000 at .05% expense ratio
50% / Short-Term Bond Index Fund (VBIRX) = $60,000 at 07% expense ratio
50% stock allocation
Stocks = $150,000 = 50% of the portfolio
40% / Total Stock Market Index Fund (VTSAX) = $60,000 at .04% expense ratio
20% / Small-Cap Value Index Fund (VSIAX) = $30,000 at .07% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $15,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $15,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $15,000 at .17% expense ratio
10% / Real Estate Index Fund (VGSAX) = $15,000 at .12% expense ratio
Bonds = $150,000 = 50% of the portfolio
50% / Total Bond Market Index Fund (VBTLX) = $75,000 at .05% expense ratio
50% / Short-Term Bond Index Fund (VBIRX) = $75,000 at 07% expense ratio
See the most current return averages based on allocation models.
Click Here*Link provides historical averages only. They will not tell you what your return will do in any given year. What it will do is help you see how different asset allocation models compare over the years based on how many stocks or bonds and cash you have in your portfolio. Use this as an educational tool to further your understanding of asset allocation.
