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Help! I’m Trying to Determine My Asset Allocation
I recently transferred a Rollover IRA and some mutual funds in a taxable account to new Vanguard accounts. Unfortunately, I have not actually done anything with either account yet. The taxable account currently consists of two funds – a S&P 500 Index fund and a global equity fund – and some cash. The IRA is completely in cash.
Asset allocation is key
After some mistakes over the past few years (more on those in a future post), I have decided to go the way of ultra-low expense index funds for these two accounts (that is why I transferred them to Vanguard). The most important component of any investing plan (other than doing something) is the asset allocation plan. That is not to say that there is one magical asset allocation that works for everyone in all situations. Rather, choosing a plan for your situation and sticking to it through thick and thin usually leads to good long-term investing results.
To make sure we are on the same page, I define asset allocation as the way in which you divide your investments to diversify your accounts. There are two layers to this (some people would call each by a different name) – your mix of asset types and your mix of specific investments within those asset types. Asset types would be cash, stocks, bonds, real estate while investments would be how you divide up the money allocated to each specific asset type. For instance, in the stock market, you could buy mutual funds covering large US companies, small US companies, international companies, etc. Don’t worry, I’m just introducing this briefly here, a full explanation is the domain of another post (or posts).
By spreading your investments across multiple asset types and multiple investments within each type, you diversify your investments. Modern Portfolio Theory has shown you can actually increase return and decrease risk by diversifying across non-correlated investments. In other words, if small US stocks are doing poorly while large international stocks are doing well, if you own both you will be doing ok. In contrast, if you owned only small US stocks, you would be in bad shape at that point. This diversification stuff isn’t something I just made up, check this out:
Give portions to seven, yes to eight, for you do not know what disaster may come upon the land. Ecclesiastes 11:2
I need to determine my asset allocation
I have a plan (low-cost index funds) now I just need to decide which ones to buy. I will simply buy a low-cost index fund in each sector that I want to cover. This will provide me with some diversification while keeping my costs very low. Now I just need to decide which funds to buy.
All the different accounts make it challenging
A big problem is that we have a bunch of separate accounts. We have a taxable investing account, a rollover IRA, a 401k for myself, a 401k for my wife, some stock and some stock options from my employer. To really optimize your investments, you would create one giant asset allocation plan and spread it across all of your accounts. You would put the tax friendly funds into your taxable accounts while putting the not-so-friendly ones into your tax advantaged accounts. (again, don’t worry, that’s all I’m saying about this here…more posts in the future will get into the details of this).
But here’s the thing – that is really hard (at least for me). The values for each account change over time at different rates. The allocation chosen today will be all out of whack next year as money is added to the 401k accounts while none is added to the rollover IRA.
I will use multiple mini asset allocations
Therefore, it makes most sense to me to split up the accounts in a way that makes it easier to manage all of them. This may not be the optimal solution but read that little paragraph at the top of the page again – "simple and straightforward" is what I like. I will either decide on an asset allocation and apply it individually to each account or group them logically (say, group the 401ks together)
I will use a "Lazy Portfolio"
I like simple and I like lazy (probably because I am simple and lazy). As a result, I will use a lazy portfolio as the basis for my asset allocation. I will start with Paul Farrell’s book, The Lazy Person’s Guide to Investing , and use one of the portfolios in there or modify one to create a portfolio with which I am comfortable. Since I mention the book here, I think I will do my book report this week on that one (don’t worry, I probably won’t do a book report every week, I just have a number of them backed up right now).
But I still don’t know exactly what to do …
I just need to set aside some time and decide. I know what I will do after I pick the allocation (shouldn’t that count for something?) I will take about 1/3 or 1/2 of the money in each of the two accounts and purchase the mutual funds I chose. Then I will dollar cost average the rest of the money into the accounts over the next few months. This will prevent me from purchasing the funds at a peak. I guess that shouldn’t really matter for long term investments, but I guess it makes me feel like I’m being prudent.
Do any of you use Lazy Portfolios?
Do you have any advice for me? I have a general plan for what I am going to do and a specific plan for how I am going to do it, I just need to settle on the final details. Does anyone have any experience with these or similar lazy portfolios? Any recommendations or advice?
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4 Responses to “Help! I’m Trying to Determine My Asset Allocation”
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I liked how you tied in a quote from the Bible. WWJD? Diversify.
Well, He did have 12 disciples…not just one!
I follow your position, but I never really saw what your planned allocation was. The general “rule of thumb” is 100 minus your age is the percentage to allocate in bond funds. The remainder should go in equities.
If you want better equity diversification, add a non-US stock fund. Better still, sprinkle (5-10%) commodoties and REITs.
Of course, you need to rebalance at least annually to maintain your percentages.
So, if you’re 25, you might want 25% in a bond fund, 45% in US stocks, and maybe 30% in foreign stocks. If you add commodities and REITs, take that percentage off your US total.
If you’re more conservative, increase your bond percentage and decrease foreign stocks.
Hope this helps! Sounds like you’re certainly on the right track reading the MPT!
@just todd – I finally ended up doing a very simple 50% US large cap, 25% US small cap, 25% International in 3 Vanguard Index funds. This is for the equity portion of my taxable investment account. I also have a number of other accounts and some cash. So while the account balances are relatively low, I am treating the cash in savings accounts as the “bond” portion. What I struggle with most is trying to keep track of all the the allocation of each account in the context of ALL of the accounts. I know it’s probably not the most optimal approach, but I just diversify each account individually and only worry a little bit about how it fits with all the others. I feel that it’s too hard to keep track of the overall asset allocation when all the accounts change at a different rate.