My own Asset Allocation vs Wellesley?

[Earl E Retyre]

Based on advice from this forum I read the book, “All about Asset allocation” (good book) and also decided not to pay an expensive financial advisor. Looking at my options for diversification and one option is to simply put the money in Vanguard Wellesly and let Vanguard rebalance for me. Seems like many on this forum may do that. The other is to create my own diversified portfolio. Taking an initial stab at the latter (and choosing low cost funds, mainly Vanguard) I came up with the table attached. Note: if I were to build my own portfolio I would call Vanguard and get some free advice first.

In comparing Wellsley performance over the last 3 years versus this portfolio and it is more or less the same.
Questions:
(1) Is it worth it to build your own portfolio to be much more diversified than Wellsley and to be more in control?
(2) Does the portfolio I created make sense?

(hopefully my attachment works and you can see it)

 

[REWahoo]

(1) Is it worth it to build your own portfolio to be much more diversified than Wellsley and to be more in control?

I'd say it depends on your individual need for control and comfort level putting all your eggs in one basket. I'm a Wellesley fan but I have only 40% or so of my portfolio in the fund. I prefer to spread the risk and diversify bit by owning other funds - mostly Vanguard.

 

[LOL!]

You didn't state if you had a taxable account or not. In general it is more tax efficient to avoid balanced funds in a taxable account and instead split bonds into tax-advantaged while using only tax-efficient stock index funds in taxable. One should also avoid actively managed funds in taxable accounts because you are subject to the whims of the taxable distribution that can be avoided if you use index funds.

I see lots of problems with your proposed set of funds. You are not using any index funds, but have selected actively managed funds. One of those actively managed funds will need an advisor to buy it: DFA funds. Anyways, you are paying higher expense ratios for those actively-managed funds.

Also so-called "growth" funds are to be avoided. One should use "value" funds and "blend" funds. All the evidence suggests that one should tilt to value which can be done by starting with index funds and then adding a "value index" fund. For example, instead of Morgan growth, use Total Stock Market Index fund and then add Small Cap Value index fund.

Also watch out for the minimum initial investment required to use a fund. You probably have enough assets over those values. That 0.75% into an energy fund is for what? Ditch it as it will have no material impact on your results. That goes for any fund with less than 5% of your portfolio value in it. So all your international funds can be combined into just 2 funds: VFWIX/VEU and VFSVX/VSS.

Ferri's "All About Asset Allocation" is dated. Vanguard has some better fund offerings since it was published. In particular, the FTSE-all-world-ex US large and small cap funds (and ETFs) are now available.

You may wish to get free financial plan from Vanguard to run their ideas past yourself. Another idea is to get the Bogleheads to pimp your portfolio.

 

[FIREd]

I agree with LOL!, you should use more index funds and stick with blend and value funds.

For what it's worth:

For domestic stocks I used VTSMX as the anchor and then added NAESX for a small cap tilt and VEIPX for a value tilt (you could also use the value index fund).

For international stocks, I used VFWIX as the anchor and then added VFSVX for a small cap tilt and VTRIX for a value tilt.

 

[W2R]

I am retired, age 61, and have a cautious approach to investing.

I am quite a Wellesley fan, and 30% of my portfolio is invested in Wellesley VWIAX. Personally I would never want to have more than 30% of my portfolio any one fund, out of an abundance of caution. The other 70% is divided among only about 5-6 other funds, though, for simplicity. This is a just a matter of personal preference, though.

 

[RonBoyd]

(hopefully my attachment works and you can see it)

(Based on the past four years history, projected forward. I think I projected out 16 years -- your age 50/retire at 66 -- but I deleted the file before I confirmed that.)





(For what it's worth, this portfolio with a 4% draw would run out of money when you are 108.)

 

[target2019]

Another good forum for financial advice is Morningstar Portfolio Design/Management. Your topic deserves discussion, and there are whole lot of questions one might ask of you. I think if you post there you won't be disappointed by the responses.

 

[yakers]

IMHO its not a crazy AA. The enemy of a good AA is pursuing the perfect AA. I agree that the large & mid cap growth funds are not necessary. I like the way you structured bonds, I can never figure out what to hold and have been reducing my total bond fund but the diversification of bonds in your AA should do well over longer periods of time. I have no opinion on the commodities/gold, I have been selling off my gold since it looks high to me. Long boglehead debates on the usefulness of commodities, I come up on the not needed side, but who knows?
I really believe in keeping things simple, this may cost some underperformance. I am mostly in index funds and DW's IRA is 65% VG Wellesley & 35% VG Star funds. This is so she can manage it herself if/when that becomes necessary.
Once you find an AA you are comfortable with you will want to hold on to it rebalancing as necessary but not playing with it too much. I have found that the part of my portfolio that I play with underperforms DW's IRA.

 

[clifp]

IMHO its not a crazy AA. The enemy of a good AA is pursuing the perfect AA.
.

I agree it a fine AA, and compared to paying some financial adviser 1% is is huge leap forward.

That said, I know it would be simpler if you replaced a dozen funds+ with three index funds. Vanguard Total Stock Market, Total Bond Market, and International Stock Market. Now if you have strong feeling or just want to indulge your testosterone, throw in a TIPs, or Emerging market bond or stock fund, or commodities. But personally I think 3 core index funds plus a couple of funds is reasonable compromise between Wellesly and the 16 you are suggesting.

Finally, when you start talking about 2% or less of your assets into specific fund (not a specific stock). I think it is worth asking yourself what am I trying to achieve. Let say you put 10K (of your 1 Million portfolio) into the Vanguard international explorer and it doubles in 3 years, while the rest of your portfolio goes up 6% The impact of having that in your portfolio is to raise your total return form 6-6.2% whoopee. Now if you want have some thing to brag about at the cocktail party or on the forum, than by all means go for it.

 

[wallygator69]

Hi,

I've been toying with the same idea but am somewhat reluctant to put all my eggs in one basket. I have started moving cash into Wellesley and various Vanguard Target Retirement Funds (2005-2020). Trying to keep stock to Bond ratio at about 45/55. I will end up with about 35-40% in Wellesley....

I learned during the meltdown of 2008 that I don't have the stomach to ride out a 50% correction without panicking and losing sleep.

Good Luck,

W

 

[Earl E Retyre]

First, thanks everyone for your input/advice - I very much appreciate how folks take so much time to help others. I do have a couple questions based on the advice.

I compared Morgan (VMRGX) to the suggested total stock market index (VTSMX) and small cap value index (VISVX). I ran some numbers assuming I put $1M in VMRGX versus splitting half a mill each in the other funds. First I ran it over the last 5 years and then I ran it over 10 years.

Interestingly, although Morgan does have a higher expense, over 5 years it outperformed the other 2. But over 10 years it did not. Even more interestingly, if I simply left my $1M in a 5% muni bond, it outperformed both the other options in 5 and 10 years. I recently became convinced that muni’s did not make sense based on the risk of inflation. But after running these numbers, and agreeing with WallyGator about stomaching a 50% correction (especially once I leave the workforce and have no other source of income), I am beginning to digress back into the muni-mindset. Obviously, when the market does take a 50% dip, then even if the next year the market comes back 50%, you are still way down.

So, I guess my two questions are:
(1) Does a lower expense ratio really mean it is the better option?
(2) Does the risk of inflation really mean muni’s are not a good option?

My spreadsheets are enclosed in case I made an error.

 

[REWahoo]

I ran some numbers assuming I put $1M in VMRGX versus splitting half a mill each in the other funds. First I ran it over the last 5 years and then I ran it over 10 years.

Interestingly, although Morgan does have a higher expense, over 5 years it outperformed the other 2. But over 10 years it did not. Even more interestingly, if I simply left my $1M in a 5% muni bond, it outperformed both the other options in 5 and 10 years.

I'd be very cautious about basing my investment decisions on what a particular fund or asset type had done over the past 5 or 10 year period. The past decade has been very turbulent and may not be representative (I hope) of what the future will hold when it comes to investing. I try to take a longer-term perspective in my decision-making.

 

[Earl E Retyre]

I can see your point, REWahoo. That is what makes this investment stuff so difficult. If I assume the past decade is not representative of what the future will hold then I could be pessimistic and assume it will be worse or I can be optimistic and assume it will be better. Obviously, no one really knows.

 

[LOL!]

Basically past performance cannot be used to predict the future with any kind of certainty since it will all depend on the performance of the asset class and not on the fund manager.

Consider that the past 10 years have been bad for stocks. Any stocks. And bonds have been OK. That means that if you use the past 10 years to see what did well, then any fund with any kind of fixed income or cash in it did better than a corresponding fund with no bonds, fixed income or cash. Since actively-managed stock funds typically have a small percentage of cash sitting around to account for redemptions and other accounting things, they did better than a 100% stock fund. But they did not do better on a risk-adjusted basis.

That's the key: risk-adjusted basis. You can take TotalStockMarket and SmallCapValue and add some bonds in order to adjust the risk downwards.

Here's a thread for you to read: Bogleheads :: View topic - Passive works because active doesn’t

You can dial in any risk that you want by mixing stocks and bonds. If you want all bonds and have a taxable account with a high tax rate, then maybe muni bonds are for you. Just be sure that your tax-advantaged space is filled with regular bonds before you use munis in your taxable.

You are making this hard because you are wasting time and effort looking at past performance. The biggest decision you have to make is what percentage of US equities, what percentage of bonds, and what percentage of foreign equities that you wish to have? After that you have to decide: Total market weights? Or add extra value equities and extra small-cap equities?

 

[REWahoo]

If I assume the past decade is not representative of what the future will hold then I could be pessimistic and assume it will be worse or I can be optimistic and assume it will be better.

Or you can be realistic and assume it will merely be different.

Kidding aside, you are correct that we simply do not know. That said, I wonder if you are trying to overthink your AA. My philosophy is the simpler the better - ever considered something along the lines of 50% Wellesley & 50% Wellington?

 

[BunsGettingFirm]

You didn't state if you had a taxable account or not. In general it is more tax efficient to avoid balanced funds in a taxable account and instead split bonds into tax-advantaged while using only tax-efficient stock index funds in taxable. One should also avoid actively managed funds in taxable accounts because you are subject to the whims of the taxable distribution that can be avoided if you use index funds.

I am addressing specifically one aspect of your reply about in which account to own balanced funds with a high bond allocation. Yes, I know this to be true as well, but let's say you early retire, and you have all of your balanced funds in an rollover IRA out of which you are withdrawing via 72(t), and most of your index equity funds in a taxable account. How would you balance into and out of this IRA? You are limited to the 72(t) rule amount each year which may cover your need to rebalanced out of your balanced funds, but how do you rebalance into your IRA? I can see the overall asset allocation getting out of whack after 5-10 years.

My plan is to replicate the asset allocation in both my taxable and and rollover IRA accounts and 72(t) from the IRA account. That way each type of account can be rebalanced on its own.

 

[WilliamG]

We have about 30% in Wellesley just to limit amount in one fund. We have enough Total International Index to have a total of 20% equity in international. With rest we use balanced funds to make overall equity allocation hit about 40%. Have decided that we like having less rebalancing to do ourselves. Fyi, the other funds are Wellington in rollover IRA, Target 2020 in my Roth and Lifestrategy Moderate in DW Roth.

 

[LOL!]

I am addressing specifically one aspect of your reply about in which account to own balanced funds with a high bond allocation. Yes, I know this to be true as well, but let's say you early retire, and you have all of your balanced funds in an rollover IRA out of which you are withdrawing via 72(t), and most of your index equity funds in a taxable account. How would you balance into and out of this IRA? You are limited to the 72(t) rule amount each year which may cover your need to rebalanced out of your balanced funds, but how do you rebalance into your IRA? I can see the overall asset allocation getting out of whack after 5-10 years.

How so? You are free to exchange funds within your IRA all you want.

If you sell equities in taxable and feel you have too much fixed income, then simply sell fixed income within your IRA and use it to buy equities. That is, exchange bonds for stocks within your IRA. There is no need to take money in or out of the IRA if you just use the assets within the IRA. You are not stuck with just a balanced fund in your IRA. You can exchange it into anything you want. Or did I miss something?

And why would you start a 72(t) plan if you have money in taxable that can be used to fund early retirement? 72(t) plans are for folks with only IRAs and other tax-advantaged investments.

 

[teejayevans]

And why would you start a 72(t) plan if you have money in taxable that can be used to fund early retirement? 72(t) plans are for folks with only IRAs and other tax-advantaged investments.

Not necessarily, you might want to do a 72t because you have some extra
room in 15% tax bracket for example (although I would do roth conversion).
TJ

 

[LOL!]

^Right, I would do a Roth conversion as well instead of a 72(t) plan.

 

[ESRwannabe]

I don't follow the asset allocation strategy because it relies on total return, which I find too erratic. If I happen to have capital appreciation that is great, but I don't count on it. My focus is on the income. People usually make the argument that dividends and selling shares are no different, which I just agree to disagree on. I think they are different.

If I were building a portfolio of stock funds, I would not buy anything that doesn't have at least a 2% dividend yield. The reason for that limit is that you can receive a 2% real return from bonds. I have no expectations in regards to share price, but I do expect for the dividend yield to, on average, grow every year, keeping up with or exceeding inflation.

I don't buy anything unless the income makes sense. For bonds, I track my own inflation rate. So, if I want to see what my current real return is going to be if I hold to maturity, I subtract my inflation rate from the bond yield.

If I want to determine if a bond fund or a stock fund is better to buy then I compare the dividend yield of the stock fund to the yield minus my inflation rate for the bond fund. Then I also take into account the characteristics of each asset.

Generally the way I judge stocks and bonds is by the characteristics of their income stream.

The benefit of bonds is that the yield is stable and predictable. The benefit of stocks is that the yield can grow and typically will outpace inflation. The downside of bonds is that the yield is stable, and will not adjust to inflation. The downside of stocks is that the yield can fluctuate, and go down.

One more important consideration is taxes. Stocks are more tax efficient in a taxable account, but it is much more than just because of qualified dividends. The reason is that with a stock fund the dividends are taxed on a "real yield" and bonds are taxed on the entire yield, i.e. the "nominal yield".

With a stock I feel comfortable spending the entire dividend. With a bond fund I need to reinvest my inflation rate. If I don't do this then over time my bond yield will decrease in real terms. A down side to this is of course that the government is going tax the full nominal yield.

 

[dex]

The question is: Where are we in the cycle? I think we have been in a cyclical bear market since 2000. It hasn't fully played out.

Looking at history is good, but picking the correct reference point to begin is key.

The next 10 years may be like none we have experienced in our lifetimes. The debt issue has not fully played out. Although, the recent focus has been on Europe, the USA is in worse shape when you factor in the state's debt issues.
USA National Debt + USA National Budget Deficit + States' Debt + States' Budget Deficits = Crisis with limited or no solution

Cash Flow needs over the next 10 years should guide your investments - allow for inflation, and increase in taxes.


Terry Laundry's T Theory™ Observations: Terry Laundry's Weekly T Theory™ Observations for May 9 2010

 

[ejman]

Or you can be realistic and assume it will merely be different.

Kidding aside, you are correct that we simply do not know. That said, I wonder if you are trying to overthink your AA. My philosophy is the simpler the better - ever considered something along the lines of 50% Wellesley & 50% Wellington?

Your comment on just simply investing in Wellesley/Wellington made me go back to my trusty Quicken investment return calculator. My annual average return from early 1987 (when I started investing) to this past Friday is 7.21 % per year. This involved an enormous level of slicing and dicing, as many as 35 funds at one time and many many hours of research and fretting and going over prospecti sp? till eyes crossed. The same period return on Wellsi/Welltn? 7.63% !

 

[REWahoo]

Your comment on just simply investing in Wellesley/Wellington made me go back to my trusty Quicken investment return calculator. My annual average return from early 1987 (when I started investing) to this past Friday is 7.21 % per year. This involved an enormous level of slicing and dicing, as many as 35 funds at one time and many many hours of research and fretting and going over prospecti sp? till eyes crossed. The same period return on Wellsi/Welltn? 7.63% !

Yep. I'm also a graduate of the School of Overcomplicated Asset Allocation.

Watch this space - we're planning a class reunion in a couple of years. I'm hoping to have my port down to only three funds by then.

 

[audreyh1]

Your comment on just simply investing in Wellesley/Wellington made me go back to my trusty Quicken investment return calculator. My annual average return from early 1987 (when I started investing) to this past Friday is 7.21 % per year. This involved an enormous level of slicing and dicing, as many as 35 funds at one time and many many hours of research and fretting and going over prospecti sp? till eyes crossed. The same period return on Wellsi/Welltn? 7.63% !

Another vote for lessons learned from the "School of Overcomplicated Asset Allocation".

IMO, you can choose three funds wisely — one balanced or broad equity index, one international, and one broadly diversified bond fund — rebalance once every 2 years, and I bet you come out ahead of anything more complicated. Especially if you ignore any market event in between rebalances.

Simplicity really seems to pay off in investing. Or perhaps it's that complexity tends to be a drag on a portfolio performance because it encourages more fiddling, probably increases taxes slightly, and generally requires quite a bit more attention and thus causes more anxiety and more chances for self second guessing.

I still maintain my slices of REITs, international small caps, mid caps, etc., but I almost always wonder if it's worth all the rebalancing trouble.

Audrey