please nitpick my Asset Allocation

[figner]

I've been overthinking this way too long, so it's time to just spew my current ideas and hope they make sense. My aim is to tweak the AA to be a Bernstein-style slice and dice portfolio (I just read "The Intelligent Asset Allocator" and found it very useful).

Here's what's proposed. I lean toward ETFs since I can buy in large enough chunks that the lower ERs will likely outweigh commissions and spread after holding for several years.

20% Large Market – VTI/VFINX
10% Large Value - VTV
10% Small Market – VB (and partly from VTI)
10% Small Value – VBR
5% REIT – VNQ
5% International Pacific – VPL
5% International Europe – VGK
5% Emerging Markets – VWO
5% International Small or Value – DLS or EFV
5% Random self-picked stocks ("play" money, or could substitute some other class?)
20% Bonds/FI (mix of vanguard CA tax exempt, TIPs, short term bond fund?)

About 30% of my portfolio is in tax-deferred accounts: 20% in a 401k with some decent but limited choices (TIPS fund, Lehman agg bond index, wilshire 4500 index-ish fund, EAFE index-ish fund), and 10% split between an IRA and a Roth at Schwab. Tax bracket is 28% federal, 9% state. No other assets or debt (such as mortgage) to speak of. I'm in my 30's and expect no pension.

It may take a while to shift over to the new AA, since about 50% of it is currently VTI and VFINX in taxable accounts with substantial nonrealized gains. I also have about 12% in individual small caps from a newsletter, most of which I plan on gradually selling over the next few years (waiting to make gains long-term, and to harvest some losses). Ideally I'd like to make changes only in tax-deferred accounts initially, then use new money to bring the taxable portion in line with the AA. Does that sounds reasonable?

Up till now I've had no experience picking bonds or fixed income investments, so suggestions on these would be much appreciated.

I can post my current AA if that would be useful, but this is getting long for now...
Thanks in advance for any comments!

[kramer]

Looks solid to me. Your REITs and fixed income should be in your tax deferred. If you can't fit REITs in tax deferred, then I would not own them (not really even a close call in your bracket).

So that means no need for California tax exempt except for emergency fund, unless you have big need for liquidity coming up (house purchase, etc.).

Also, I would think carefully about keeping as much as 80% equities, but that depends where you are at in your investing lifecycle and also your tolerance for risk.

Since you are still working, you can focus less on TIPs for fixed income since your wage should track inflation. Larry Swedroe recommends something around 30-40% TIPs for fixed income component for current TIP valuations (~2.45-2.5%) for those that are already retired. So you could skip them and go with short term bonds, or maybe devote only half of what Swedroe recommends.

Some would recommend a dollop of DJP for tax efficient commodities futures. My own opinion is that this is pretty marginal in your situation due to some subtleties I won't go into here. If you are an asset class junkie, like me, you could do 2-4% in that (but there is tax risk, no official IRS ruling yet).

Many recommend skipping small market altogether and just going with small value. I think if it were me, I would go with 5% small market and 15% small value. VBR is not very tax efficient due to being 15% REITs but it is worth holding due to the outstandingly low ER (.12%) which mostly makes up for that.

Some would also recommend taking that 5% and instead of investing in small market, going with BRSIX, which is ultra small from Bridgeway Funds (more or less passively managed). Again, this is pretty marginal and it is not perfectly tax efficient,and the fund has large embedded gains. Anyway, that is how I did it, and did not own small market.

I am only making recommendations at the edges. Nice work. Really.

Kramer

[ashtondav]

Hi

Why not invest some of the equity portion in dividend yielding shares/etfs/funds? A reasonable expectation would be 3% or 4% yield increasing by inflation over the long term. I live in the UK and it's a very popular strategy that's worked fro many years. It does not seem to have caught on in the same way in The USA. I can't figure out why.

[brewer12345]

I would include some commodities and non-USD bonds, too.

For FI, you could do a lot worse than AGG or the VG total bond market index fund. Alternatively, you could buy treasuries at auction, perhaps splitting the money equally between a 6 month T bill, a 2 year note and a 5 year note.

[LOL!]

Which pays more nowadays: 6month T-bill, 6 month CD, money market fund?

[milmoose]

Since you are in your 30s, I would recommend allocating less than 20% to bonds.

Instead:
10% Managed Commodity Futures (via PCRIX or DJP)
5% Inflation linked bonds (I-Bonds or TIPS)
5% Short-Intermediate term Treasuries

No need to tax advantaged or corporate.

Overall, very solid though. Nice tilt towards small-cap and value factors for your equity exposure.

- M

[soupcxan]

Quote:

Originally Posted by milmoose Since you are in your 30s, I would recommend allocating less than 20% to bonds.

Even for a young investor, holding less than 20% bonds greatly increases portfolio risk with only a tiny increase in return. I don't think the tradeoff is worth it, even if you have a voracious appetite for volatility.

[Brat]

Take a look at EPP (Pacific x Japan) as an alternate to VPL.

[figner]

Quote:

Originally Posted by kramer Also, I would think carefully about keeping as much as 80% equities, but that depends where you are at in your investing lifecycle and also your tolerance for risk.

Thanks for the comments. Regarding the equities percentage, I've been 100% in equities for the last 10 years, so adding 20% fixed is already a pretty big shift for me. I was finally convinced by reading "The Intelligent Asset Allocator" that 20% would be beneficial. I'm not real worried that I'll panic sell due to volatility, but giving up a small amount of returns for a much better chance of being on track for ER seems worth it. I hope to be FI in 5-7 years, with ER in 10-13.

Quote:

Originally Posted by kramer Some would recommend a dollop of DJP for tax efficient commodities futures. My own opinion is that this is pretty marginal in your situation due to some subtleties I won't go into here. If you are an asset class junkie, like me, you could do 2-4% in that (but there is tax risk, no official IRS ruling yet).

If you'd care to expand on this, I'm curious about the explanation.

Quote:

Originally Posted by kramer Many recommend skipping small market altogether and just going with small value. I think if it were me, I would go with 5% small market and 15% small value. VBR is not very tax efficient due to being 15% REITs but it is worth holding due to the outstandingly low ER (.12%) which mostly makes up for that.

Part of the reason for the small market allocation is that I already have a chunk embedded in VTI (total market index) - depending on whether I lump the mid-caps in with large or small, that could be up to 10% of my current portfolio already. How do folks here generally classify mid-caps?

I guess VBR is better off in my IRA if there's room. Will look at BRSIX too.

Quote:

Originally Posted by brewer12345 I would include some commodities and non-USD bonds, too. For FI, you could do a lot worse than AGG or the VG total bond market index fund. Alternatively, you could buy treasuries at auction, perhaps splitting the money equally between a 6 month T bill, a 2 year note and a 5 year note.

Any recommendations on a non-USD bond fund? I like the simplicity of AGG, but according to Bernstein going above 5-year bonds is low on the reward:risk ratio. I'm mainly looking for bonds to be a non-correlated asset, and it seems short-term bonds would accomplish that with the least amount of risk.

My 401k offers a Lehman agg index fund, the Vanguard High-Yield Corporate fund, and a Short Duration Bond fund which "seeks to modestly outperform the total return of the Merrill Lynch 1-3 Year Index while limiting the risk of underperformance versus the index." There's also a TIPS fund, but I'm guessing I'd be better off buying a TIPS ladder with taxable funds. Which option or combination would you pick?

Quote:

Originally Posted by ashtondav Why not invest some of the equity portion in dividend yielding shares/etfs/funds? A reasonable expectation would be 3% or 4% yield increasing by inflation over the long term. I live in the UK and it's a very popular strategy that's worked fro many years. It does not seem to have caught on in the same way in The USA. I can't figure out why.

I know some who do this, but I guess I haven't found a compelling reason myself. If in a taxable account, the annual tax bite would lower returns by a fair amount, so using funds with low yield is my way of deferring taxes. This might be a good tool after retirement in a low tax bracket, though.

Quote:

Originally Posted by Brat Take a look at EPP (Pacific x Japan) as an alternate to VPL.

Could you explain the reasoning behind this? Are you saying to consider not investing in Japan at all, or would this be a way to split out Japan in a separate fund?

[brewer12345]

Non-USD bond fund: BEGBX right now. When it gets back to a discount to NAV, I like GIM better. But both are fine.

The Lehman Agg index has a duration of roughly 4, which is pretty moderate. If the agg index fund in your 401k has low expenses, it would be a good choice. Stay away from the junk fund; it will be correlated with the equity market and the junk market is foolishly overvalued at the moment.

[Brat]

EPP vs VPL

Quote:

Originally Posted by figner Could you explain the reasoning behind this? Are you saying to consider not investing in Japan at all, or would this be a way to split out Japan in a separate fund?

Callouses acquired waiting for Japan to recover are showing! Japan has a developed economy and is heavily weighted in VPL. I think the biggest A-P growth in the next 20 years will be x-Japan. True, I am tweaking the total market approach but I would go for a little juice for this small % of the portfolio.

EPP has been down the last couple days but it looks like it has been impacted by the AU $ (I don't think it is a hedged fund).

[milmoose]

Even for a young investor, holding less than 20% bonds greatly increases portfolio risk with only a tiny increase in return. I don't think the tradeoff is worth it, even if you have a voracious appetite for volatility.

I disagree. Real estate, commodities (or Managed Commodity Futures), Timberland or Absolute Return can all achieve similar diversification benefits to bonds.

I agree that a 90% equity portfolio is suboptimal. An 80% equity portfolio with 20% in "alternatives" (in this case bonds and commodities) is far more efficient.

- M

[wabmester]

For youngsters with no fear of volatility, consider the Yale approach:

pdf link

Only 5% bonds, and only 15% US stocks.

[figner]

Quote:

Originally Posted by milmoose I disagree. Real estate, commodities (or Managed Commodity Futures), Timberland or Absolute Return can all achieve similar diversification benefits to bonds. I agree that a 90% equity portfolio is suboptimal. An 80% equity portfolio with 20% in "alternatives" (in this case bonds and commodities) is far more efficient.

If I felt comfortable with another asset class that was similarly non-stock-correlated, I'd happily substitute some of that for part of my 20% bond allocation. At the moment I don't consider myself well-informed in this area, so bonds are the default non-stock asset class based on my limited reading. I'd be more prone to buy real estate if the valuations didn't look so bubbly - as it is I'm sure I'll feel trepidation pulling the trigger to buy 5% REIT.

Is Absolute Return different from picking a managed fund that times the market?

[figner]

Quote:

Originally Posted by Brat EPP vs VPL Callouses acquired waiting for Japan to recover are showing! Japan has a developed economy and is heavily weighted in VPL. I think the biggest A-P growth in the next 20 years will be x-Japan. True, I am tweaking the total market approach but I would go for a little juice for this small % of the portfolio.

Funny, that affects me in the opposite way - it's less stressful for me to buy things that have been languishing for a while.

[brewer12345]

Quote:

Originally Posted by wab For youngsters with no fear of volatility, consider the Yale approach: pdf link Only 5% bonds, and only 15% US stocks.

Great, so 25% hedge funds and 15% private equity. I can get that at Schwab, right?

[figner]

Quote:

Originally Posted by brewer12345 Non-USD bond fund: BEGBX right now. When it gets back to a discount to NAV, I like GIM better. But both are fine.

Thanks. At first glance I'm leery of the relatively high (.82%) expense ratio on BEGBX, though that's probably because I'm used to paying under .2% with equity index funds. Will do some more poking around to see if it's worth the diversification benefits to me.

Quote:

Originally Posted by brewer12345 The Lehman Agg index has a duration of roughly 4, which is pretty moderate. If the agg index fund in your 401k has low expenses, it would be a good choice. Stay away from the junk fund; it will be correlated with the equity market and the junk market is foolishly overvalued at the moment.

My ignorance is showing again - I forget if Bernstein's 5-yr number refers to duration or maturity. Time to hit the books tonight!

[wabmester]

Quote:

Originally Posted by brewer12345 Great, so 25% hedge funds and 15% private equity. I can get that at Schwab, right?

Brewer, if you built it, they will come. I already allocate about 1% to my brewer fund, and I'm considering upping that number.

[brewer12345]

Quote:

Originally Posted by wab Brewer, if you built it, they will come. I already allocate about 1% to my brewer fund, and I'm considering upping that number.

Actually, Schwab rolled out a Long-Short equity fund last year with a large expense ratio and slick marketing. Not sure how it has done.

You'll have to take up the hedge fund thing with the SEC. Only qualified investors need apply, as things stand.

[brewer12345]

Quote:

Originally Posted by figner Thanks. At first glance I'm leery of the relatively high (.82%) expense ratio on BEGBX, though that's probably because I'm used to paying under .2% with equity index funds. Will do some more poking around to see if it's worth the diversification benefits to me.

Barclay's has said they are thinking about launchng an ishares non-USD bond ETF. I will be eager to see it when it becomes a reality. In the meantime, I think BEGBX and GIM (at a discount to NAV) are the best options.