Asset Allocation Percentages

[km4hr]

Stories in the media continue to emphasize the importance of asset allocation. They say we need to maintain a certain percentage of bonds and stocks. But I wonder if this advise was established during a long period of falling interest rates, a situation that no longer exists. Does the advise need to be updated to take into account the current rate environment? Right now I'm a little heavy in stocks. So I'm thinking about "allocating" more into bonds. But with interest rates low it seems more likely that bonds will loose value. So I'm wondering if I should follow (perhaps outdated) conventional wisdom and buy bonds or should I go to cash instead? Shouldn't the advise be modified to take into account the current low rate enviroment?

 

[grumpy]

I would recommend that any new allocation to bonds or bond funds in the current rate environment be to short durations. These will not fall in value much if rates continue to rise.

Grumpy

 

[yakers]

I agree with Grumpy. If you are going to go into bonds keep them short or maybe even mid term bonds but avoid longer ones. But AFAIK asset allocation does not call for a specific kind of bond but for "fixed income" so you could look at CDs for this same type of allocation. I also have ibonds which are a bit different and some people recommend TIPS if you have a tax deferred/free way to carry them. I agree about fixed income being an important part of an AA but there are a number of ways to approach it. I expect some folks to get as burned with bonds as they did with stocks a few years ago.

 

[JohnnieRed]

A lot of studies on your topic...the investor is not fairly compensated for risk of duration above 5 years...
Fama,Eugene "Time Varying Expected Returns", Feb. 1988...right now 0-2 years seems best for fixed income in rising rate environment...

 

[TromboneAl]

KM,

No one knows what's going to happen with interest rates. That's why asset allocation works.

If you knew what was going to happen with the stock or bond market, then you'd just put 100% in the asset type that's going to go up.

 

[Gone4Good]

No one knows what's going to happen with interest rates.   That's why asset allocation works. 

I agree with your instincts here.  How many of us sold down long bond positions two years ago because we just knew interest rates were going up??  I know I did.  But it strikes me that if we all think interest rates can only go up, and we are all sitting in cash waiting for them to go up, we create a tremendous impediment to rising rates.  I'm a firm believer in going against the grain and adding to areas that everyone is down on (bonds, converts, maybe even US large caps) and selling areas that everyone is excited about (commodities). 

But the reason to own fixed income is because of its ability to diversify a portfolio and reduce volatility.  Countless studies have concluded that fixed income investments reduce a portfolio's volatility without dramatically reducing expected returns.

Vanguard also makes a good point that rising interest rates actually increase fixed income returns for long-term investors in an article titled “Interest Rates, Bonds and Misconceptions”  However, if you can actually predict the future direction of interest rates than you will do better moving in and out of bonds based on what your magic 8 ball is telling you.  But I don’t think it is any easier to predict future interest rate movements than it is to predict future equity market movements.  As a result, I am starting to move money back into longer duration bonds to “fix” the mistake I made when I sold down earlier. 

 

[wildcat]

Yrs -

I'm curious to see your current allocation. Do you mind posting it?

Also Large Caps, although a cold are to be for the last 3 years or so, still seem kind of pricey to me based on: yields are not great, buybacks @ 52 week highs are telling me there are fewer +NPV projects that warrant investment (could be for tax purposes), sitting on a lot of cash w/o paying it back to shareholders (could waste it on crappy acquisitions), pensions liabilities, health care liabilites, etc. Just seems like better returns could be had in other areas. Could be cold for a reason.

I suppose the argument could be made that rising int could put an end to small cap run as it becomes more expensive for them to raise capital.

 

[Gone4Good]

Yrs -

I'm curious to see your current allocation.  Do you mind posting it?

Mostly vanguard funds, but a smattering of other stuff.

Tax-Exempt Money Market                               28%
Tax Exempt Bonds                                           7%
Global Bond Fund                                             4%
Convertible Securities                                       3%
Individual stocks                                              4%
500 Index Fund                                              14%
Mid-Cap Index Fund                                        13%
Small-Cap Index Fund                                      13%
Total International Stock Index Fund                    6%
International Explorer Fund                                 6%
REITs                                                               2%


Bonds & Cash              39%
   Domestic                89%
   International           11%
Equities                        57%
   Domestic                80%
   International             20%
Convertible Securities    3%


wildcat - I don't normally kill a lot of brain cells thinking about whether corporate cash on US balance sheets is going to hurt future returns, or whether China is going to use up all of the world's oil, or . . .   because I'm really not that smart, after all.  I prefer to stick to an allocation that makes sense (to me) and "tilt" it toward areas that have under performed and away from areas that have out performed.  My REIT allocation was higher at the beginning of the year and my S&P index allocation has been growing.  But so much has "outperformed" lately that I don't really feel good about putting money to work anywere.

 

[NYCGuy]

km4hr,

The problem with the standard stocks+bonds asset class mix, promoted by investment vendors, is that there isn't enough diversification to protect you when you really need it, in a crash like 73-74 or 87. Stocks and bonds are not uncorrelated asset classes. They are merely less correlated. This is another way of saying that markets are riskier than they look. In order to find asset classes with lower correlations you have to go beyond the standard menu choices. One good book for this is "How to Retire Early and Live Well on Less Than A Million Dollars" by Gillette Edmunds. Edmunds retired in his thirties and has lived off his investments since. His perspective is interesting because unlike most financial writers, he is an investor, not an investment "professional" with a product to sell. Consequently, he is very realistic and savvy about the nuts and bolts of retirement investing. Asset classes he recommends to add to stocks and bonds are: oil and gas trusts, directly owned commercial real estate (e.g. an apartment building), gold, etc.

 

[Merlin]

Edmunds retired in his thirties and has lived off his investments since. 

And, of course, the royalties from the books he has written.

 

[azanon]

What's your time horizon KM?  Anyone giving you advice here without that information doesn't know what they're talking about.  If you need the money 3 months from now, put it in a money market fund.   If you have 2-3 years, you maybe can handle a bond fund of some type or those hybrid "income" funds that hold mostly bonds (see Janus Flexible Income, for instance).  If you're looking at 6+ years, go for stocks.  Re: the 6 year+ situation, read a few articles by Peter Lynch about the superiority of stocks.

Time horizon is a critical, non-optional bit of information when it comes to deciding what your portfolio should look like.  I have a stable job and in my early 30s;  clearly my portfolio should be more aggressive than somone here who's retired and couldn't get their job back anymore.

Azanon

 

[LOL!]

Is there a good program or web site that will give one the asset allocation of one's portfolio in terms of large cap (value & growth), mid cap (v&g), small cap, international (large, small, v & g), fixed income (divided into maturities), REITs, timber, commodities, etc?

I have MS Money 2002 and it doesn't do this. I have used the Morningstar X-ray feature, but it's style box is not quite the same as "asset allocation".

Any hints or pointers for me? Thanks!

 

[JPatrick]

A good read is "Live it up without outliving your money" byPaul Merriman.  A great book for beginners and plenty of interesting factoids for the seasoned investor as well.

 

[Spanky]

Is there a good program or web site that will give one the asset allocation of one's portfolio in terms of large cap (value & growth), mid cap (v&g), small cap, international (large, small, v & g), fixed income (divided into maturities), REITs, timber, commodities, etc?

I have MS Money 2002 and it doesn't do this. I have used the Morningstar X-ray feature, but it's style box is not quite the same as "asset allocation".

Any hints or pointers for me? Thanks!

Try financialengines.com
https://www.financialengines.com/FeContent?act=welcome

 

[LOL!]

financial engines costs too much money now. I remember using it in the early days one could get a 30-day free trial

 

[Nords]

I remember using it in the early days one could get a 30-day free trial

If you remember your login/password, it might still be free.

I joined in '98 or '99 and I've never paid, yet I still maintain our portfolio there and update/tweak occasionally.

 

[Chris24]

Any other options out there ? And for those that use it , is it worth the price ? I use mornigstar premium . like most things about it but wish it were clearer about allocations. Does AAII have anything close to financial engines ?

 

[ESRBob]

And, of course, the royalties from the books he has written.

At about a buck a book, it's safe to say he (or any author in this area) isn't getting rich of that part of his portfolio!

I also like Gilette Edmunds' first book (haven't read the one on REITs) because of its emphasis on getting clear of the markets and into illiquid and quite uncorrelated asset classes.

An ER friend of mine, former wall street highflier, said: I don't want to own things that I can buy and sell with a click of my mouse. And I certainly don't want to pay somebody else a fee for managing things that can be bought and sold with the click of a mouse.

He has helped steer me into a few things like royalty trusts (haven't bought there, yet) and a hedge fund that provides capital to banks who are putting together 'conduits' to create asset-backed securities. Things like that have risks so different from anything in the broad markets that I like to own them just for their diversification, and the fact that (in the latter case) it is throwing off a steady 20% a year doesn't hurt either. That one's closed to new investors, but things like it are out there if you start looking.

I think an ER who is only ever asking for 4-5% a year cash out of a portfolio can better afford illiquid investments than the average investor, and can capitalize on that with a little independent thinking.

 

[Merlin]

At about a buck a book, it's safe to say he (or any author in this area) isn't getting rich of that part of his portfolio!   

ESRBob,

Thanks for your comment.  I purchased your book last week and your methods should move ER time several years closer for me.  Thanks!

 

[JohnnieRed]

Two other good books on Asset Class Allocation Percentages for various risk levels are:

"The Four Pillars of Investing, Lessons for building a winning portfolio" by William Bernstein

and

"The Prudent Investor's guide to Beating Wall Street at Its own Game" by John Bowen and Daniel Goldie.

The Berstein book actually illustrates various Vanguard portfolios for various risk levels.  Bernstein includes the knowledge and tools investors need to assemble low risk, winning portfolios without professional advice.

 

[brewer12345]

An ER friend of mine,  former wall street highflier, said:  I don't want to own things that I can buy and sell with a click of my mouse.  And I certainly don't want to pay somebody else a fee for managing things that can be bought and sold with the click of a mouse. 

He has helped steer me into a few things like royalty trusts (haven't bought there, yet) and a hedge fund that provides capital to banks who are putting together 'conduits' to create asset-backed securities.  Things like that have risks so different from anything in the broad markets that I like to own them just for their diversification, and the fact that (in the latter case) it is throwing off a steady 20% a year doesn't hurt either.  That one's closed to new investors, but things like it are out there if you start looking. 

I think an ER who is only ever asking for 4-5% a year cash out of a portfolio can better afford illiquid investments than the average investor, and can capitalize on that with a little independent thinking.

I like my wonky partnerships for yield and absolute return. The other illiquid asset I really like is start-up community banks. They usually go through a few rounds of capital raising as they grow, but most of them sell out after 5 to 10 years and returns are generally excellent (20+% a year), but you have to be patient.

 

[JohnnieRed]

What is a wonky partnership?

Know a big real estate investor, apartment buildings and warehouses, he just started a private bank...think he's going that route before long....suspect he has only his own and friendly investors private monies in the bank...likely to finance the sale of his real estate when he diversifies?... unclear as to timing of getting public money, either as debt or equity, into his bank

He's too shrewd for me to get involved with...

 

[ESRBob]

I like my wonky partnerships for yield and absolute return. The other illiquid asset I really like is start-up community banks. They usually go through a few rounds of capital raising as they grow, but most of them sell out after 5 to 10 years and returns are generally excellent (20+% a year), but you have to be patient.

Brewer,
Nice -- that is the sort of thing I think we long term investors and ERs should be looking into -- it takes time and braincycles to figure out, and there is obviously illiquidity and some different types of risk there, but it is that very differentness that I think serves us well in the portfolio -- and you won't hear about this stuff in the mainstream press or fund company ads. The local banks that grow up and sell to the big boys have been pretty consistent performers, I understand, but have never invested in any myself.

 

[ladelfina]

Xray

Went briefly to the Morningstar Xray site. I didn't enter everything, just one fund, PFIOX, that I ended up with after Safeco merged with Pioneer...

Now I'm more confused than before.

Morningstar shows PFIOX as having 48% cash.  I thought I was invested in the market rather than holding cash!

Yahoo! Finance says .04% cash, not 48%...

This number is not furnished on the Pioneer site, but I'm about to sit down with a calculator and tally up the figures given for their holdings list (cash not listed) and see how that compares to the total of holdings.


Has anyone else seen odd discrepancies of this kind? Who to trust without crunching all the numbers yourself?

---
ok back editing this post to report the sum total of all the different share classes does add up, just about, to the bulk of all holdings. 99.-something%. So why would Morningstar report otherwise
---------

 

[lazyday]

Re: Xray

Has anyone else seen odd discrepancies of this kind?

Tons. M* has lots of bad data, both online and in print edition.

Who to trust without crunching all the numbers yourself?

I place more trust in original sources. If you can't find summarized data on the fund website, there might be some in the annual or quarterly reports, which you can get from the SEC Edgar website.

I still use M*'s data to make decisions, but take with a big grain of salt, and try to instead use data from index providers or etf/index fund providers, including Vanguard and ishares.