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how do you pick an asset allocation?
Old 06-28-2014, 08:57 PM   #1
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how do you pick an asset allocation?

This must have been covered before but I can't find it...

I'm closing in on my retirement numbers, and should be going from the accumulation phase to the withdrawal phase in the next 2 years.
How do you decide what your asset allocation should be during retirement? I'm in my 30s so I have a long time horizon. FireCalc seems to default to 75/25 stocks/bonds, and that may be appropriately aggressive. If I go to 50/50 stocks/bonds the success rate goes down.
Are there any books I should be reading that help me figure this out?
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Old 06-28-2014, 10:04 PM   #2
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There are many "formulas" out there to figure your asset allocation. The classic one says you should have (100 - your age) in stocks. So if you are 35 years old, you should have 100-35=65% in stocks. As you get older, you should therefore have less and less in stocks. Then people figured out that this formula may be too conservative, so now it seems to have become (110 - your age) in stock. Then, recently, a paper suggested that you should start your retirement with little invested in stock and then increase your stock allocation throughout retirement.

So, as you can see, there is no universally accepted approach.
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Old 06-29-2014, 12:42 AM   #3
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I'm finally reading "The Four Pillars of Investing" by William J. Bernstein -- thanks to a tip on this forum, I was able to purchase the Kindle version earlier this month while it was on sale at Amazon for $1.99, suchadeal!

I think this book explains asset allocation very well.

(Alas, it's now back to $16.50 at Amazon, but maybe you can find it at your local library.)
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Old 06-29-2014, 05:48 AM   #4
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FIREcalc allows you to calculate probabilities based on varying AA.

Go to INVESTIGATE tab, then investigate changing my allocation.
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Old 06-29-2014, 08:32 AM   #5
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There is an Asset allocation tutorial? thread.

I would suggest Rick Ferri's book "All About Asset Allocation" and getting some experience. The reality is that one can simply take the asset allocation found in a Target Retirement or Life Style fund and tweak it. Those funds generally will have
a US stock fund
an Int'l stock fund
and a Bond fund
at a bare minimum and one can see the percentages of each fund. There are plenty of "rules of thumb" that one can adjust for their own personal beliefs.

For example, this "age in bonds" thing is something that I don't believe in. There is the "110 - age" in stocks thing, too. For some people that is just right, but for the risk averse (NOT adverse!), that might be too high in stocks.

The US:international split is something asked about, too. Anywhere from 50:50 to 80:20 is probably reasonable and may not even matter.

There's more, but that's a start.
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Old 06-29-2014, 09:39 AM   #6
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IIRC from 40% to 80% equities the success ratio doesn't change much. Play around with https://retirementplans.vanguard.com...estEggCalc.jsf or other tools to see the impact of different AA on success. So in my view at the end of the day it boils down to what allows you to sleep best at night as long as you are in that 40-80% band. I use 60/40.
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Old 06-29-2014, 03:09 PM   #7
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Quote:
Originally Posted by pb4uski View Post
IIRC from 40% to 80% equities the success ratio doesn't change much. Play around with https://retirementplans.vanguard.com...estEggCalc.jsf or other tools to see the impact of different AA on success. So in my view at the end of the day it boils down to what allows you to sleep best at night as long as you are in that 40-80% band. I use 60/40.
+1.

If you are stretching for 4% withdrawals you might be better at the higher end of the equity range.

Also notice the ending portfolio average in addition to the SWR. That's why I sacrifice a tiny bit of SWR safety and go with 100% equities (even in retirement). Not many are willing to put up with that, but I was stressed in 2009 because I couldn't find more cash to buy more equities.

A few here also go with almost no equities. Why risk anything if you don't have to?

I'd start with 40% - 80% as a baseline and deviate from that only once you have experience and feel strongly about doing it differently.

A good example would be your favorite Vanguard Target Retirement fund. It has the minimal basic funds and you can see how much of each they use for each date.
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Old 06-29-2014, 08:21 PM   #8
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...A good example would be your favorite Vanguard Target Retirement fund. It has the minimal basic funds and you can see how much of each they use for each date.
Here is the glide path. https://advisors.vanguard.com/VGApp/...0306#GlidePath
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Old 06-29-2014, 09:15 PM   #9
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Classic is good enough for me. Simple allocation, simple math
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Old 06-29-2014, 11:18 PM   #10
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I really appreciate all your replies. Looks like I'll be reading some books and browsing the web more.
It does feel a little like people use their gut to pick the exact AA, but at least I can try and use an informed gut.
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Old 06-30-2014, 06:23 AM   #11
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Hi nu,
here're some more portfolios: Invest Simple with Lazy Portfolios - MarketWatch.com
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Old 06-30-2014, 09:01 AM   #12
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Model portfolio allocations
https://personal.vanguard.com/us/ins...io-allocations

Develop a suitable asset allocation
https://personal.vanguard.com/us/ins...uth-about-risk
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Old 06-30-2014, 09:03 AM   #13
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Long term it depends on (sequence of) real returns. FIRECALC (among other resources) can show what long term probability of success has been historically. Each of us has to then confront (and live with) for ourselves how history may relate to the future - more optimistic, pessimistic, other. There simply aren't any guarantees, only probabilities.

Short term (a year or less) it depends on how much you can afford to lose, mentally and relative to your probability of success (FIRECALC among other resources). IOW what kind of potential loss allows you to sleep at night - see chart below.

Many of the online risk tolerance quizzes will help individuals determine an AA that fits their individual needs. Here's one https://personal.vanguard.com/us/FundsInvQuestionnaire
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Old 06-30-2014, 09:52 AM   #14
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I have two different AAs, one for my IRA which I won't need to tap into for at least 8 or 9 more years, and one for my taxable accounts whose monthly dividends I use to cover my expenses. For the IRA, I was 55/45 for years but changed to 50/50 last year when I turned 50 (following the "age in bonds" principle I kinda like). For the taxable accounts, I am far more bond-weighted because I need the income. I am in the 37/63 range now although I will adjust it to meet my income needs, not any age or arbitrarily chosen AA.
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Old 06-30-2014, 12:41 PM   #15
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Originally Posted by nuisance View Post
I really appreciate all your replies. Looks like I'll be reading some books and browsing the web more.
It does feel a little like people use their gut to pick the exact AA, but at least I can try and use an informed gut.
There are tons of starter AA possibilities because for the most part, staying within the reasonable bounds, there are minor performance differences between them. No need to over think it.

One of the main benefits of using an AA is that it gives you the rebalancing targets and keeps you from trying to time the market. Those two things plus just being invested in the market get you most of the benefits.
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Old 01-08-2015, 09:39 PM   #16
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Hopefully for the benefit of people who stumble on this thread in the future, here's what I ended up doing:

I read "The Four Pillars of Investing" by Bernstein. It seemed not very clear where asset allocations come from, but did recommend "Asset Allocation: Balancing Financial Risk" by Gibson, which I then read. It contains a lot of good background (and is the first thing I've read that talks about the efficient frontier). I got a trial version of Kwanti's Portfolio Analytics software, which was great for getting a feel for what the efficient frontier means in practice. (Big takeaway: It's pretty sensitive to the input assumptions, and those numbers feel like a guessing game.) Finally I read "All About Asset Allocation" by Ferri, which has some nice very specific suggestions.

The bottom line is that I very much agree with Animorph's post above:
Quote:
There are tons of starter AA possibilities because for the most part, staying within the reasonable bounds, there are minor performance differences between them. No need to over think it.
Here's the asset allocation I ended up deciding on:
30% us stocks
10% us small value
5% european stocks
5% pacific rim stocks
5% emerging markets stocks
5% international small
10% us reits
30% us bonds

Thanks again for all your suggestions.
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Old 01-08-2015, 10:08 PM   #17
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This is what I studied to design my AA. Great illustrations of the efficient frontier.
http://www.investorsolutions.com/upl...egies_21st.pdf
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Old 01-08-2015, 10:12 PM   #18
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Quote:
Originally Posted by nuisance View Post
Hopefully for the benefit of people who stumble on this thread in the future, here's what I ended up doing:

I read "The Four Pillars of Investing" by Bernstein. It seemed not very clear where asset allocations come from, but did recommend "Asset Allocation: Balancing Financial Risk" by Gibson, which I then read. It contains a lot of good background (and is the first thing I've read that talks about the efficient frontier). I got a trial version of Kwanti's Portfolio Analytics software, which was great for getting a feel for what the efficient frontier means in practice. (Big takeaway: It's pretty sensitive to the input assumptions, and those numbers feel like a guessing game.) Finally I read "All About Asset Allocation" by Ferri, which has some nice very specific suggestions.

The bottom line is that I very much agree with Animorph's post above:


Here's the asset allocation I ended up deciding on:
30% us stocks
10% us small value
5% european stocks
5% pacific rim stocks
5% emerging markets stocks
5% international small
10% us reits
30% us bonds

Thanks again for all your suggestions.
When you get tired of managing the Europe, emerging markets, pacific rim and international small allocations, you can just roll it into international large and international small.
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Old 01-08-2015, 10:57 PM   #19
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Anytime I see an asset allocation with international split up into those fine bits, I know someone has read an old edition of Bernstein or Ferri. Times have changed; new international index funds are now available; tax laws are different; these authors are recommending something different nowadays: simplification.

Here's another discussion on asset allocation that might be worthwhile reading:
http://www.bogleheads.org/forum/viewtopic.php?t=38374
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Old 01-09-2015, 10:41 AM   #20
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I saw this a couple of times, but can't find my original source. That is, for a usual <4% withdrawal rate, the effect on asset allocation isn't huge except at the extremes (all or mostly bonds / all or mostly stock). Best I could find was this paper by Wade Pfau. Look at Figure 2 for the bottom two lines which are 3% and 4% withdrawal rates. Not much difference. The difference is larger for higher withdrawl rates, but then again, the percentage of years with no remaining wealth is large no matter what you do.

http://mpra.ub.uni-muenchen.de/34536...aper_34536.pdf
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