Looking for input on asset allocation

[ER Eddie]

I'm fairly new to investment. Currently my money is in three Vanguard funds: Target Retirement 2015, Life Strategy Moderate Growth and Wellington funds. As I've been learning more, I have seen a number of shortcomings in my current setup.

To make a long story short, I'm thinking about shifting everything to the asset allocation below. But, since I'm still pretty new at this, I thought it would be a good idea to check it out with the forum first, before I went ahead.

For context, I am 51 years old, and I plan to shift from full-time to part-time work in about one year. I will continue working part-time as long as I enjoy it. As far as risk tolerance goes, I am probably in the moderate or perhaps low-moderate range.

Anyhow, here is the allocation I'm thinking about. Tell me if this seems reasonable:

All funds purchased through Vanguard.

60% stocks, 40% bonds.

Of the stocks, 70% would be in US funds, 30% in international.

Of the US stocks:
- 60% in Vanguard 500 Index fund
- 20% in Mid-cap Index fund
- 20% in Small-cap Value fund

Of the international stocks:
- 75% in Developed Markets Index fund
- 25% in Emerging Markets Index fund

Of the bonds:
- 50% Short-term Index Bond fund
- 50% Intermediate Term Index Bond fund


Does that seem about right? Is there anything significant that I am overlooking?

Thanks in advance for any input.

 

[LOL!]

You could simplify this and have a similar asset allocation.

First, did you know that Total Int'l Stock Market index is about 25% emerging markets already? So instead of those 2 int'l funds, you could simply have a Total Int'l Stock Market index fund.

By the same token, for US stocks, you picked 3 funds. You could have simply chosen the Total US Stock Market index fund. Is there some reason that you split US into 3 funds? If you wanted to tilt to small-cap, you could have 2 funds: Total US Stock Market Index and a Small-cap value index fund.

Your current Target Retirement and Life Strategy funds hold the Total Int'l Stock and the Total US Stock funds, don't they?

 

[pb4uski]

Your target AA is exactly the same as mine. I have ER'd about 18 months.

On the bond side, I hold 6% (~ 18-24 months of spending) in cash and cash equivalents (3% in an online savings account and 3% in short term bonds) and the remaining 34% in bonds. Of the 34% in bonds, 80% are domestic bonds and 20% are international bonds and the domestic bonds are 80% investment grade and 20% high yield.

I would suggest that you consider adding some international bonds and possibly some high yield bonds to the bond side.

Another thing you could do is to have Vanguard's financial planners do a plan for you and see what suggestions they have. And I agree with LOL! that you can simplify your funds.

Another thing to consider is tax efficient placement of your portfolio. Luckily, my tax deferred accounts are large enough to hold my entire bond allocation plus some equities and my taxable and tax-free accounts are all equities.

 

[ER Eddie]

You could simplify this and have a similar asset allocation.

First, did you know that Total Int'l Stock Market index is about 25% emerging markets already? So instead of those 2 int'l funds, you could simply have a Total Int'l Stock Market index fund.

Good suggestion, thank you. I was trying to reach the 25% percentage for emerging markets suggested by Steven Davis (Retire Early, Sleep Well), but perhaps 19% (what the Total fund allocates to emerging markets) is close enough.

By the same token, for US stocks, you picked 3 funds. You could have simply chosen the Total US Stock Market index fund. Is there some reason that you split US into 3 funds? If you wanted to tilt to small-cap, you could have 2 funds: Total US Stock Market Index and a Small-cap value index fund.

Yeah, that was the result of my tweaking Mr. Davis' recommendation, which was for a 50/50 split between what he called the S & P 500 fund (now the Vanguard 500) and small cap. I wasn't comfortable with so much in small cap, so I tweaked his percentages so it was 50/25/25, large/medium/small. Perhaps I overcomplicated things.

If I can just use the Total US Stock index fund, plus a small cap index fund to "tilt" in that direction, that might do the trick. Seems like small cap is a good place to be, and I've only got 3% in it right now. I want that closer to about 25%.

Your current Target Retirement and Life Strategy funds hold the Total Int'l Stock and the Total US Stock funds, don't they?

They do, and they have the advantage of also holding about 8% in the International Bond Index funds that Pb4uski mentions. On the other hand, they have about 15% in International Stock index funds, and I'd like it to be about twice that. The Retirement 2015 fund is too conservative for me, with only about 52% in stocks, and no longer fits my plans (I will continue to work part-time). They also have slightly higher expense ratios than the Admiral index funds.

I would suggest that you consider adding some international bonds and possibly some high yield bonds to the bond side. [...]

Thanks, that's a good idea about adding international bonds. I hadn't considered that. I don't know what high yield bonds are, so I'll probably steer clear of those until I know more.

Another thing to consider is tax efficient placement of your portfolio.

Yes, I wish I understood this piece better. Every time I try to read about it, my eyes glaze over, lol. I'll come to grips with it eventually.

 

[pb4uski]

.....I don't know what high yield bonds are, so I'll probably steer clear of those until I know more.

Yes, I wish I understood this piece better. Every time I try to read about it, my eyes glaze over, lol. I'll come to grips with it eventually.

High yield bonds are just bonds issued by issuers whose credit rating (by Standard & Poors, Moody's or Fitch) are lower than investment grade so while there is more credit risk (that the issuer will have financial troubles and be unable to pay interest or principal) they also offer higher returns.

The basic premise of tax efficient placement is that you want to hold investments that generate higher levels of income that is taxable in tax deferred accounts and hold investments that generate lower levels of income that is taxable in taxable or tax free accounts. In my case, most of the dividends from my equity mutual funds are qualified dividends and are not taxed for someone in my tax bracket, so those investments go into my taxable account. On the other hand, dividends from bond mutual funds are subject to tax so those investments go into my IRA which is tax-deferred. See this link for details.

 

[MichaelB]

One thing I notice when members post their YTD portfolio returns is how similar they are despite the different asset allocations. The same hold true at B*heads when they compare different portfolio structures. Here is a recent blog post by Mebane Faber comparing different portfolio returns. Asset Allocation Strategies – Mebane Faber Research – Stock Market and Investing Blog

The law of diminishing returns applies here. More tweaking will result in lower marginal benefit. In other words, the allocation looks fine, the major asset classes re covered, and you can put a lot more time and effort into it but aren't likely to get that much more as a result.

+1@pb4uski's suggestion to focus on tax. It has potential to deliver more future spendable $ now that your basic allocation scheme is set.

 

[ER Eddie]

Yeah, I've been playing around with Vanguard's Portfolio Tester, and I've noticed that most of the tweaks I introduce don't change the historical performance much at all (average return, gains in good years or losses in bad years, etc.) -- at most, it's by a few tenths of a percentage point. Still, it's fun to play around a little.

Here's what I've got now:

60/40, stocks/bonds.
Of stocks, 75% in US, 25% international.
Of bonds, 80% in US, 20% international.

So it would be 5 index funds:

- Total Stock Market Index (90% of US stocks)
- Small-cap Value Index (10% of US stocks)
- Total International Stock Index (25% of all stocks)
- Intermediate-Term Bond Index (80% of bonds)
- Total International Bond Index (20% of bonds)

Average expense ratio is 0.10%, which is a little less than before (0.16%). The large/med/small cap ratio is now 58/25/17, which suits me better than the previous 85/12/3). I get all "ok" messages on my analysis -- no more "caution" or "consider" notes -- which I take to be a good sign.

Even though it probably won't make a whole lot of difference in the outcome, I do think I have considerably more diversification now, a bit fewer expenses, less redundancy, and more emphasis on international and small-cap funds, which were lacking before. I also think it will be easier for me to understand how my portfolio is doing (vs. the lumpy funds I had before) and to rebalance it when necessary.

 

[LOL!]

That's a good asset allocation, but YOU have to believe in it or you will not follow it through good times and bad times. At least you have written it down, so now write down how you will rebalance and when you will rebalance.

 

[ER Eddie]

I believe, baby, I believe! I've never been one to try to time the market. I'm not that smart, and from what I've seen, no one else is either. I understand that this is a "buy and hold" philosophy, designed for the long haul. I am only just now arriving at what I feel is minimal competence in this area. I don't think I'll be someone who thinks he knows how to tweak percentages in response to market trends. As long as I've got something reasonably solid, I'll just sit on it and wait.

Aside from yearly tweaks to get things back in line, I may change the percentages when I enter bona-fide retirement (i.e., stop working part-time) or when I get to around 60.

 

[obgyn65]

To the OP : very rarely you will find consensus about AA on this website. Some posters are more risk takers than others. So let me ask you : what level of AA are YOU comfortable with ?

 

[Major Tom]

To the OP : very rarely you will find consensus about AA on this website. Some posters are more risk takers than others. So let me ask you : what level of AA are YOU comfortable with ?

I don't see a great deal of disagreement over different AA's between members here. I think you have experienced a lot of questioning in the past due to the fact that your portfolio consists almost entirely of fixed income investments and thus represents an extreme (in this group, at least).

For the majority here who rely, to different degrees, on equities, I don't see much dissent.

I'm trying to remember the last argument I saw between someone who was 50/50 and someone who was 70/30...........

 

[obgyn65]

You may have missed some interesting threads

However, it seems that the posters at Bogleheads may be more conservative than here on average (more like me) and have a higher fixed income portion of their AA. I may be wrong, though.

I don't see a great deal of disagreement over different AA's between members here. I think you have experienced a lot of questioning in the past due to the fact that your portfolio consists almost entirely of fixed income investments and thus represents an extreme (in this group, at least).

For the majority here who rely, to different degrees, on equities, I don't see much dissent.

I'm trying to remember the last argument I saw between someone who was 50/50 and someone who was 70/30...........

 

[Midpack]

However, it seems that the posters at Bogleheads may be more conservative than here on average (more like me) and have a higher fixed income portion of their AA. I may be wrong, though.

Do you have any basis for stating Diehards tend to be more conservative? I'd guess Bogleheads typically have the same or higher equity exposure AA's than members here, mostly because the average age there is lower as it's not a retirement forum. No in depth research/evidence but this shows 87% of them fall between 20-70% equity, often considered the most popular AA ranges. Bogleheads • View topic - Poll for 65+ Seniors

 

[clifp]

I don't see a great deal of disagreement over different AA's between members here. I think you have experienced a lot of questioning in the past due to the fact that your portfolio consists almost entirely of fixed income investments and thus represents an extreme (in this group, at least).

For the majority here who rely, to different degrees, on equities, I don't see much dissent.

I'm trying to remember the last argument I saw between someone who was 50/50 and someone who was 70/30...........

Me neither, anything from 40/60 to 80/20 is considered fine and FireCALC and most other retirement calculators will show only modest difference in survival rates, max SWR what have you within that range. Most long forum members understand that and don't argue much with in the range.

Since this is an Early retirement board, I think this is primarily for those retired or planning on retiring between 45 and 62, if somebody below 45 wants a 100% equities that also seems fine, and somebody over 62 wants only 20% equities that is cool also.

 

[obgyn65]

Point taken. As I said, I may be wrong but it's the impression I got.

Do you have any basis for stating Diehards tend to be more conservative? I'd guess Bogleheads typically have the same or higher equity exposure AA's than members here, mostly because the average age there is lower as it's not a retirement forum. [/URL]

 

[ER Eddie]

To the OP : very rarely you will find consensus about AA on this website. Some posters are more risk takers than others. So let me ask you : what level of AA are YOU comfortable with ?

I'm pretty comfortable with the AA I laid out, based on what I know, such as it is. Some of the advice I was getting made me a little edgy. For instance, Steven Davis, whose book Retire Early, Sleep Well was very educational (and an easy read for a newbie like me) advised a higher percentage in small caps and international funds than I was comfortable with, so I dialed those percentages back a little.

I was just checking with the forum to see if I'd made any huge boners. Apparently only small ones.

 

[In-control]

One thing I notice when members post their YTD portfolio returns is how similar they are despite the different asset allocations. The same hold true at B*heads when they compare different portfolio structures. Here is a recent blog post by Mebane Faber comparing different portfolio returns. Asset Allocation Strategies – Mebane Faber Research – Stock Market and Investing Blog

The law of diminishing returns applies here. More tweaking will result in lower marginal benefit. In other words, the allocation looks fine, the major asset classes re covered, and you can put a lot more time and effort into it but aren't likely to get that much more as a result.

+1@pb4uski's suggestion to focus on tax. It has potential to deliver more future spendable $ now that your basic allocation scheme is set.

I agree. If you have a well deviersified balanced fund allocation is built into a well balance fund - that'swhat the management fee is supposed to be for. Last year my Vanguard FP told me that I did not have enough international exposure. I explained to him that the Wellesley Income fund that I am in has a 6% exposure and as long as I can get between 7-8% yield per year while l having the lowest possible risk I was good.

I originally had multiple funds but have simplified to just a few. My main fund is VG Wellesley. I have two funds that are higher risk, VG Health and High yield Corp. Both are @ 5% allocation. I keep my allocation of 40% Stocks/50% bonds/10% cash by moving $ between Fidelitys Stock and Bond index funds in a IRA account. This keeps my Cap Gains low.

John Bogle suggests using your age for your bond allocation. This assumes that your retiring in your mid 60's I believe. He also suggest having a Total Stock and Bond Market index fund and that's it. Suggesting that the companies that make up those index funds are global and capture that market.

Simplisity may be boring - but you have less stress and you get, from my experience, the same or better results. I also try to stay away from lifestyle funds as they charge a fee for the fund then a fee for each individual fund within that fund. All this just for an allocation % which you can acieve using the portfolio tracker asset allocation tool and a handful of index funds.

 

[web_diva]

Suggest checking out David Swensen's Yale Endowment permanent portfolio. it's an AA one keeps the same in all market conditions, hence the "permanent" part.

 

[photoguy]

Anyhow, here is the allocation I'm thinking about. Tell me if this seems reasonable:

How different is your proposed allocation from your existing one? It's hard to say because your existing funds are mixes.

It might help compare the two, if you put your data into a tool like morningstar's x-ray and see how much change there really is.

 

[ER Eddie]

How different is your proposed allocation from your existing one? It's hard to say because your existing funds are mixes.


It might help compare the two, if you put your data into a tool like morningstar's x-ray and see how much change there really is.

I did -- I used Vanguard's tool, called the Portfolio Tester, where you can run before & after analyses to your heart's content.

The most significant changes were:

1. The ratio of large to med to small cap stock investments changed from 84 large/13 med/3 small (before) to 58 large/25 med/17 small (after). Before, Vanguard was giving me a "caution" signal that my ratios were overemphasizing large caps, but not anymore. The new ratios are more in line with the actual market, with a little extra emphasis on small cap value funds (my preference).

2. Investment in international stocks rose from from 16% to 25% (of total stocks). Percentage of US stocks dropped a similar amount. Before, Vanguard was suggesting I consider investing more in international funds.

3. Investment in international bonds went from about 7% to 20% (of the bond funds). Percentage of US bonds dropped accordingly.

I think that gives me a little more diversification, and it shores up areas where I was under-invested.

There were a couple of non-quantifiable changes, too:

4. It's now simpler for me to understand, since each fund is a single type, whereas before, each fund was a mixture of many types, so it was hard to know what an increase or decrease meant. Now I can understand what is going on more easily.

5. Before, my portfolio seemed rather hodge-podge and redundant (e.g., TR 2015 and the Life Strategy funds are very similar). Now it seems more clear cut and in line with the "all-index, all the time" approaches suggested here and elsewhere.


Overall, I feel good about it. I think I came away with a more clear-cut, understandable, and diversified mix.

I appreciate the input.

 

[photoguy]

I didn't know vanguard had a portfolio tester -- I will check it out.

The only thing that I see which might be controversial is the amount in international bonds. The material I've seen from vanguard on this has not been particularly convincing (to me) but I haven't researched this in depth. In any case, a 20% allocation of 40% is not going to make/break a portfolio.

 

[panhead]

The AA looks good to me and is somewhat similar to what I presented to the forum months ago (that's why it looks good to me, lol!). My only suggestions are that:

1) Before you do anything, understand the tax implications of buying/selling what you have if some of this is in taxable.
2) Understand tax efficient placement before you do this so you can get this right the first time.
3) Write up an IPS (investment policy statement, search bogleheads). This will be something you can go back and look at when things get crazy and you don't understand what you did and why. It will also give you directions on rebalancing, and anything else you want to track.
4) Once you feel you have decided on your AA, sit on it without doing anything for a little while (week, month, whatever) to see if it still looks good after that time period.

Good luck to you!

-Pan-

 

[Lsbcal]

A very smart poster on Bogleheads some years ago posted that he had some of his large cap allocated to mid cap. He also value tilted so this was in mid value.

The reasoning: large cap value (in French-Fama "speak") was negatively loaded on size whereas mid cap value was not. So by moving some of the LV to MV he could hit his targeted size/value loading for his overall portfolio. Most of us including me do not use size/loading numbers to construct our portfolio. Still I think pushing some large to midcaps is a good idea.

Over the last 21 years (of my data sample) midcap value has beaten large cap value and even small cap value. This seems to be lost on so many or explained away as recency bias. Seems to me that 21 years is a good enough sample.

 

[Chuckanut]

Another thing to consider is tax efficient placement of your portfolio. Luckily, my tax deferred accounts are large enough to hold my entire bond allocation plus some equities and my taxable and tax-free accounts are all equities.

+1

A good point. There is no reason to turn tax advantaged capital gains into more highly taxed regular income. Just make sure that as far as possible you use a tax efficient stock fund that doesn't generate taxable gains from excessive trading.

Bonds? I am sticking with a an intermediate fund and a short term fund since I do think rates have to go up sooner than later. But, I have been wrong about this for quite a while.

 

[ER Eddie]

I didn't know vanguard had a portfolio tester -- I will check it out.

Yeah, if you go to "Portfolio Watch," the link is at the bottom of the page. It's a nice little tool, especially if you're doing some major reshuffling.

The only thing that I see which might be controversial is the amount in international bonds. The material I've seen from vanguard on this has not been particularly convincing (to me) but I haven't researched this in depth. In any case, a 20% allocation of 40% is not going to make/break a portfolio.

Hmm. Ok, thanks for the input. I did see that Vanguard suggested 20% as being a reasonable figure. I'll keep my ears open, though.

The AA looks good to me and is somewhat similar to what I presented to the forum months ago (that's why it looks good to me, lol!). My only suggestions are that:

1) Before you do anything, understand the tax implications of buying/selling what you have if some of this is in taxable.

Woops, too late. I already made the move.

2) Understand tax efficient placement before you do this so you can get this right the first time.

I'll have to settle for getting it right the third or fourth time. Par for the course for me, lol.

I tend to get lost in tax talk. I am good at math, but I'm not good at translating foreign languages into English, so I have trouble understanding taxbabble. I have trouble staying awake during it, too. They ought to bottle that stuff as a sleep aid. I know I need to know it, but my god, you'd think someone could explain it clearly and simply for us non-accountants.

Something my CPA said rang true, though -- he thinks they keep the terms and formulas intentionally vague to keep people confused and off balance. Wouldn't surprise me.

edit: I'll have to spend some time at this page, which pb4uski kindly linked for me earlier:
http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement

3) Write up an IPS (investment policy statement, search bogleheads). This will be something you can go back and look at when things get crazy and you don't understand what you did and why. It will also give you directions on rebalancing, and anything else you want to track.

Hm, okay, I'll check that out.

4) Once you feel you have decided on your AA, sit on it without doing anything for a little while (week, month, whatever) to see if it still looks good after that time period.

Yeah, well, where were you four days ago.

Good luck to you!

Thank you!