Asset Allocation feedback

[inquisitive]

I finished reading Ferri's book, which was recommended here recently, created my first ever asset allocation plan, and would appreciate feedback. It is for a retirement account. I have access to funds through Fidelity and just looked at NTF funds. I think I have a high risk tolerance, although Ferri writes about how people generally overestimate their tolerance for risk. I am willing to start with this allocation and see if I maintain it. I am in my late twenties and am planning on rebalancing once/year. The rough percentages are to the right. The expense ratios range from 0.10% to 1.12%. I summarized the division by country and type of investment below.

[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity Spartan® Real Estate Idx Inv[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.62[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® China Region[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.49[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Matthews Korea Investor[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.55[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® International Discovery[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.50[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® Select Biotechnology Portfolio[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 4.78[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® Select Medical Delivery Port[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 4.74[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® Select Utilities Portfolio[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 4.77[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® Nordic[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.50[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity® Latin America[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.54[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Fidelity Spartan® Extended Mkt Index Inv[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.52[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Matthews Asia Growth Investor[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.46[/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif]Matthews India Investor[/FONT][FONT=Verdana, Arial, Helvetica, sans-serif] 9.53[/FONT]

Total: 88% stock, 12% real estate

Country Breakdown
United States – 33%
Latin America – 9.5%
South Korea – 9.5%
India – 9.5%
Sweden/Denmark/Finland 9.0%
Japan – 6.4%
Other Europe – 5.5%
Other Asia – 4.3%
China 4.2%
Hong Kong 2.9%
Taiwan 1.2%
Other or combination of above – 5%

I calculated 3 year correlation coefficients of all mutual funds against each other, took the average of all of them (not sure if this is the right way to do it) and got a mean correlation of 0.59. There is a lot of diversification, both geographically and currency.

There are no bonds, which is because I have a long time horizon, the long-term performance of stocks is higher than bonds, and I am willing to experience temporary drawdowns. If interest rates rise I don't think the returns of bonds the last few years will persist. I don't know much about bonds and am open to arguments for including them and would purchase some if I thought their long-term performance would exceed stocks. If I was to buy bonds I would be interested in corporate and perhaps emerging market bonds.

Thanks for any input!

 

[LongPrime]

I once did diversification over different companies and assets and tracked in MS Money. It got way to complicated to track and the expenses became negligible in relation to losses in class. Others may have other experiences.

 

[karluk]

I find your choice of investments to be offbeat to the point of being downright eccentric. I suspect you are guilty of overthinking your asset allocation. It's hard to justify, for example, a decision to put twice as much money into Korea as in China, even though China has roughly ten times as large of an economy.

The net result is that you probably aren't properly diversified. Why should you expose your portfolio to the risk that the Korean economy might suddenly tank? I see a lot more risk than reward here.

That said, the fascinating thing about the stock market is that an oddball allocation such as yours might very well perform splendidly, if you're lucky enough to pick more winners than losers. You pays your money and you takes your chances, just like everybody else.

 

[panacea]

I'll say upfront I didn't read the book, but that allocation looks way to complicated. Also, the focus seems to be on diversification in international markets. The allocation seems far too light in U.S. exposure. I absolutely wouldn't consider anything less than 50% in U.S.; Personally my target for U.S. is 70% of overall stocks with the remaining 30% in foreign (1/3 of that in emerging markets). Lastly, I think chasing specific sectors can get you in trouble... for example, biotech can do exceptionally well in one year and in the tank the next. I'm sure there was good reasoning for all of this in the book, so needless to say this is all IMHO.

 

[racy]

I finished reading Ferri's book...created my first ever asset allocation plan,...I think I have a high risk tolerance .... I am willing to start with this allocation and see if I maintain it. I am in my late twenties ...
Thanks for any input!

Hi inquisitive,
My input: keep reading, studying, calculating and, most importantly, keep investing. Your greatest advantage is your youth and time: which will have a greater impact on your wealth accumulation than asset allocation.
I agree with others who think the allocations are overly complex, but hey, I say go for it! Why not. You have time and appear to be a student of the game.
Good luck!

 

[Animorph]

It's certainly interesting. You might want to double check how diversified each of those funds are. Some country and sector funds can have large holdings in just a few companies.

We have no standard answer for such an unusual portfolio. So you're pretty much on your own. It is heavy with non-U.S. equities, though so is my portfolio. Are you U.S. based? Let us know how it goes.

 

[walkinwood]

Here's Rick's own allocation (as of 2010) in pretty pictures
Portfolio Manager Rick Ferri Shares Personal Portfolio and Asset Allocation — My Money Blog

 

[MichaelB]

I finished reading Ferri's book, which was recommended here recently, created my first ever asset allocation plan, and would appreciate feedback.

Nice first effort. Two questions that may help others as they try to help you.

What is your benchmark for measuring risk and performance?

How do you plan to rebalance?

 

[frank2009]

As others have said, way too complicated. Also, are you sure you can handle volatility the that comes with such a high percent of your portfolio in equities? If yes, maybe consider 10% in your Fidelity REIT index and 90% in Vanguard total world index.

 

[mrfeh]

I'd say it's unnecessarily complicated.

What percentage do you want in US equites? Put that in FSTVX.
What percentage do you want in ex-US equities? Put that in FSGDX.
The rest goes into fixed income (and I do suggest you put some percentage in fixed income).

Then you can play around the edges with emerging markets, small value, REITS.

 

[Rdub]

Check out this article by Paul Merriman.
6 steps to the ultimate retirement portfolio - MarketWatch

I personally like the way he approaches portfolio management. My overall portfolio is along the path of Paul's with several exceptions, due the location of my assets (401ks, Roth IRAs, Brokerage acts, rental properties, etc) and what funds are available within those asset locations. When in doubt, I try to simplify.

Due to my high tax bracket (fed/state), I try to be as tax efficient as possible. I keep my high income investments (Bonds, REITs, Tips, etc) in my tax advantaged accounts (401ks & Roth) and other investments in my taxable accounts. However, in order for me to reach my target bond %, I need to have some of my bond exposure in my taxable accounts. I hold CA muni bonds to get the additional bond exposure and tax free income.

There is no "one size fits all portfolio" since we all have unique situations, time horizons and risk tolerances. I try to understand the various concepts (asset allocation along with asset location) and manage my accounts/assets according to my personal plan.

To summarize, I focus on:
Saving money (max 401k, ESPP, roth conversions, live below my means, etc)
Asset allocation / location
Investment expenses
Tax efficiency

Below are a few books you may find interesting:
The Gone Fishin' Portfolio- Alexander Green
The New Coffee House Investor- Bill Schultheis

Hope this helps!

 

[samclem]

I agree with those who say it is more complicated than I would want. I have been guilty of this myself in the past--reading just enough about this country or that sector and buying a MF to goose up my holdings in a particular type of security. Now I have most of my holdings in broad indexes but have some $$ in small and value index funds that I have achieved the "tilt" I want while keeping expense ratios and complication very low.
In addition, assuming you live in the US and expect to pay your bills here, I think your share of US holdings is lower than I would want. You'll be exposed to uncompensated currency risk. I'd be okay with up to 35% foreign companies, but that's about it. And the "bets" are decidedly offbeat.
Bonds: Not having any probably won't hurt you at this point.
Consider: Putting 80% of your portfolio into low-cost, broadly diversified index fund. With the remaining 20%, have fun with your country and sector bets. The fun and allure will wear off and you'll probably save a lot of money in expenses and endure lower volatility.

 

[inquisitive]

Thanks for all the feedback. I am going to re-think some things. To answer some of the questions:

I'll say upfront I didn't read the book, but that allocation looks way to complicated. Also, the focus seems to be on diversification in international markets. The allocation seems far too light in U.S. exposure. I absolutely wouldn't consider anything less than 50% in U.S.; Personally my target for U.S. is 70% of overall stocks with the remaining 30% in foreign (1/3 of that in emerging markets). Lastly, I think chasing specific sectors can get you in trouble... for example, biotech can do exceptionally well in one year and in the tank the next. I'm sure there was good reasoning for all of this in the book, so needless to say this is all IMHO.

There is no reasoning for most of this in Ferri's book; it is about principles which I have tried to follow.

It's hard to justify, for example, a decision to put twice as much money into Korea as in China, even though China has roughly ten times as large of an economy. The net result is that you probably aren't properly diversified. Why should you expose your portfolio to the risk that the Korean economy might suddenly tank? I see a lot more risk than reward here.

I will re-think my regional diversification. I thought I had similar amounts in China and Korea, but looking at the individual funds after you mentioned this, I realized the Korea fund is 100% in Korea, but the China fund is only 44% in China with other big allocations to Hong Kong and Taiwan, so that I am investing the same amount in that entire region as in Korea.

Similar to the point about the Korean economy tanking, should I reduce my US allocation as well? I have 33% there including real estate, which would be at risk if the US economy tanks. Or do people justify more US holdings because the size of the US economy (maybe 45% of the world market capitalization)?

Nice first effort. Two questions that may help others as they try to help you.

What is your benchmark for measuring risk and performance?

How do you plan to rebalance?

Thanks for the feedback. I plan to rebalance yearly by returning all positions to the initial percentage allocation.

I have no benchmarks for measuring risk, and nothing for performance in the short-term. A common benchmark is the S&P 500, but properly designed portfolios can underperform the market for 1 and even 2 year periods, but unlikely to underperform over a 3-year period. So after a year if my portfolio does worse than the S&P 500 it would not mean anything unless I made some mistakes in the initial construction (which maybe I have). One of the main points in Ferri's book is to select noncorrelated assets that have a positive long-term expectation. So he specifically excludes commodities. He also gives an example of allocation to US small cap and large cap, and not to do it based on market capitalization; eg small and micro cap comprise about 10% of the US stock market but people will allocate to small and large cap equally because they behave differently, some years small caps outperform large caps, and vice versa, and there are some different causes of the difference in performance. He also gives an example of breaking up a big foreign index into regions because if you have it in one index, you are missing the opportunity to rebalance the individual components, and thus losing some benefit of asset allocation. Maybe I have taken this too far by going to the country level.

It's certainly interesting. You might want to double check how diversified each of those funds are. Some country and sector funds can have large holdings in just a few companies.

I looked at individual positions and the largest is 1% of the portfolio, the 10th largest is 0.65%. This sounds like too much? Is there a guideline of how much is the maximum to allocate to a single company? The 1% is in the vanguard US real estate index with really low expense ratios, so the only way to reduce it would be to switch to a different US real estate fund with a much higher expense ratio, reduce my allocation to this fund, or do both.

Lastly, I think chasing specific sectors can get you in trouble... for example, biotech can do exceptionally well in one year and in the tank the next

The reason for the biotech and medical delivery funds are that I work in the healthcare field and think that these will do well over the long-term. I allocated half of the position of each other fund to them because they are sector funds. I don't have a good reason for the Utility fund and think I will get rid of it. I did a lot of reading on a lot of companies and industries and it seemed like there was still significant infrastructure development to happen in American utilities, but I'm thinking this is just a mistake and maybe I will remove all sector funds entirely. I am okay with them fluctuating in the years as long as they do well long-term but maybe it's not a good idea to have any sector funds in the mix.

About being complicated, it's true, but I'm literally not planning on looking at it again for a year, so I don't think it will take too much time to manage.

 

[rayvt]

The reason for the biotech and medical delivery funds are that I work in the healthcare field and think that these will do well over the long-term.

Well, that's two good reasons to NOT own those funds.
Once you figure out why I say that -- whether you agree or disagree -- you'll have learned a lot about investing that you need to learn if you plan to be successful at it.

I'll add my voice to those who say that this is offbest and way too complicated. Especially for someone who is just starting out.
You didn't say how much money you have in this account, but with 12 holdings it needs to be a lot. As in 6-digits or more.

I would recommend either the FSTVX & FSGDX, or the Merriman asset allocation.

 

[MichaelB]

I have no benchmarks for measuring risk, and nothing for performance in the short-term. A common benchmark is the S&P 500, but properly designed portfolios can underperform the market for 1 and even 2 year periods, but unlikely to underperform over a 3-year period. So after a year if my portfolio does worse than the S&P 500 it would not mean anything unless I made some mistakes in the initial construction (which maybe I have). One of the main points in Ferri's book is to select noncorrelated assets that have a positive long-term expectation.

Got it. One thing you can do is build a benchmark portfolio with roughly similar weightings but based on low cost ETFs. for example, for the equity portion 1/3 total US, 1/3 EM and 1/3 Non-US developed markets, and for the real estate one
additional ETF. Total 4 ETFs, which you can track alongside your own to see if you are adding value. You really do need something against which you can compare your performance.

 

[Gotadimple]

Thanks for all the feedback. I am going to re-think some things.

Inquisitive,
You may want to go over to Morningstar.com and register as a user (it's free). Then take the allocation you propose and load it into Instant X-ray. Click on Tools, scroll down to Portfolio, click on Instant X-ray in the second row of tools.

Load each of your selected funds with the relative $ amount into the tool, then run X-Ray. You will get an overall look at your entire allocation as X-Ray takes all the components of each fund and analyses the country and sector exposure. That might help you with determining a simpler allocation - or just point out where you have doubled exposure unintentionally.

Rita

 

[walkinwood]

In his book "stocks for the long run", Jeremy Siegel showed that there is an inverse correlation between economic growth and long-term equity returns. You have a lot in high growth areas of the world. Those stocks have high expectations already built in.

Stocks For the Long Run is a good book to read. But keep your mind open to others who criticize Siegel's work.

 

[inquisitive]

Thanks again for all the feedback. I did some more reading and thinking and came up with a revised allocation which I am planning on going with. I couldn't really do what I wanted to do because I tried to pick lower expense ratio funds from the ones that are offered, and many funds grouped together many countries which didn't allow me to reduce allocations to specific regions. At some point if/when I leave this company I will switch it to an IRA so I can choose ETFs. I got rid of sector funds and added 10% bonds (a mix of US/intl, corporate and emerging market, including sovereign debt). I also decided I did not want too much in any single country, including the US. The maximum allocation to any country excluding the US is 6.5%. So my overall allocation is:

80% stock, 10% real estate, 10% bonds
Overall: 30% US, 70% international
Stocks: 20% US, 80% international

I am investing in 10 funds. This will allow me to achieve more diversification that in investing in 4 funds (eg, US, international, real estate, bonds). I plan on maintaining this allocation for 1 year and then will re-balance and consider adding/removing funds. It is an aggressive portfolio given the % of stocks and also all the bonds are high risk.

For anyone else thinking about asset allocation, there are some good links above, in addition I am going to use the following as benchmarks, which are also interesting examples:
Invest Simple with Lazy Portfolios - MarketWatch.com
The Gone Fishin' Portfolio: The Ultimate Index Fund Portfolio - Investment U

I'm not convinced that the lazy portfolios are calculated correctly because when I click on some of them for the details, they don't all add up to 100% but I think the overall result should be pretty close.

 

[mathjak107]

so many funds would make my hair hurt. just no need for that many. in fact i do not see much real diversification as the whole portfolio is just based around equities being the golden child going forward.

 

[target2019]

Inquisitive,
Do you have access to Fidelity Spartan funds in your 401k?

 

[inquisitive]

It is more diversified than a portfolio that is FSTVX, FSGDX and a bond fund, or one that has an equity division of 70% US, 30% international. If it looks nondiversified because the equity portion is 80% international, the international component cannot be thought of as being homogenous, there is no more relationship between South Africa and India than there is between the US and China.

I do have access to some Spartan funds but have to pay a sales load which I am okay with doing, in fact one of my funds is FSIVX, a spartan international fund.

 

[inquisitive]

so many funds would make my hair hurt. just no need for that many. in fact i do not see much real diversification as the whole portfolio is just based around equities being the golden child going forward.

That is a good point regarding diversification. I'm not going to allocate more to bonds. Per Ferri commodities, including metals, do not have a long-term positive return and he does not recommend any allocation to commodities. So this basically leaves stocks, real estate, and bonds. The futures funds have had an awful performance. I could increase real estate to a higher allocation but I am okay with having 10% there. I think the long-term performance of stocks is higher than real estate and I recognize this is a risky portfolio.

 

[retirementguy1]

Hi, in your last post you mentioned that your 10% bond allocation are high risk. Just keep in mind that in a bear market high yield bonds behave like equities which defeats the purpose of buying bonds.

I do agree that most portfolios have bias towards US equities and there are some valid reasons. Even though the rich complain about taxes and the poor complain about opportunities the US is still the most business friendly country in the world and American workers are still the most efficient as far as hours worked translating into GDP. Accounting procedures for developing nations are not nearly as strict the US and Europe. In the last year the company Caterpillar had to write off $1b due to fraudulent accounting of a Chinese partner. Just a few things to think about.

The problem for me is that I do have an attraction to the slice and dice portfolio but with every investing book I read I want to change my allocation. If you hold money in taxable accounts this can eat away at your return and will nullify rebalancing.

Best of luck.

 

[eta2020]

Looking at expense of those funds.... This would be one very expensive portfolio.

 

[inquisitive]

Hi, in your last post you mentioned that your 10% bond allocation are high risk. Just keep in mind that in a bear market high yield bonds behave like equities which defeats the purpose of buying bonds.

I do agree that most portfolios have bias towards US equities and there are some valid reasons. Even though the rich complain about taxes and the poor complain about opportunities the US is still the most business friendly country in the world and American workers are still the most efficient as far as hours worked translating into GDP. Accounting procedures for developing nations are not nearly as strict the US and Europe. In the last year the company Caterpillar had to write off $1b due to fraudulent accounting of a Chinese partner. Just a few things to think about.

The problem for me is that I do have an attraction to the slice and dice portfolio but with every investing book I read I want to change my allocation. If you hold money in taxable accounts this can eat away at your return and will nullify rebalancing.

Best of luck.

It doesn't defeat the purpose of buying bonds, it just decreases the benefit. But the bonds still have lower volatility than stocks and there is still diversification benefit because of the regions/companies invested in. So think of it as an 80%+ stock portfolio.

Part of my rationalization for the second point is the efficient market hypothesis. Plus the capital gains rate increased in the US which will have some effect on US investment.