One strategic approach to investing is to buy a particular mix of investments that you believe will provide the return you’re seeking at a level of risk you’re willing to take. This is what we refer to as asset allocation and is nothing more than bringing the concept of diversification into an investment strategy.
The reason that asset allocation can help is that each asset class, or investment category, tends to perform in a different way from the others in particular economic conditions.
I was on my commute the other day and while listening to Rob Berger from doughroller, he shared the analogy between asset allocation aka diversification and Elaine Benes from Seinfeld. At first, I was lost and didn’t understand what the heck he was talking about but then he referenced the episode where she hits the dance floor.
This episode is hilarious and I encourage you to watch it. It is in my top 10 and is the one where she starts dancing in front of a crowd with complete absence of coordination. After reflecting on his message that is exactly the behavior I’m looking for in a portfolio. Some asset classes going up while some are down and vice-versa.
If you invest in both stocks and bonds over a period of time, you’ll be in a better position to avoid the level of loss you’d suffer in a stock downturn if you only owned stocks, or in a bond downturn if you own only bonds.
When it comes to allocation models, you’ll see there’s a plethora of information out there most centered on investment horizon and risk tolerance; however, it all boils down to how well your strategy matches your financial goals.
Asset Allocation Models
In an asset allocation model, stocks represent growth and are essential to long-term investment planning because historically they tend to increase in value. While it’s possible to lose a lot of money in the stock market in any year, the longer you stay in the market the more likely you are to come out ahead.
Financial experts may recommend you have as much as 80% of your total portfolio in stocks (stock mutual funds) while you’re in your 20s and 30s and scaling back as you into your 50s and 60s. Obviously, the idea is to shift more of the assets into income-producing investments or those that preserve capital.
What Should your Asset Allocation Look Like?
Remember the word “personal” in Personal Finance (PF)?. Well, just like you’d expect (or maybe not), this is something you’re gonna have to figure out. What I can do is share resources to facilitate making informed decisions.
When I got started, I didn’t even know what asset allocation was so I googled the heck out of it. I was overwhelmed by the amount of information but realize I had to start somewhere. My research led me to a company I had heard great things about from the PF community. It didn’t take me too long to realize it was the perfect partner for my investment strategy. This company was Vanguard.
We opened 2 Roth IRAs and decided to invest in their target date retirement funds. These funds invest in thousands of U.S. and international stocks and bonds, including exposure to the major market sectors and segments. The funds’ managers gradually shift each fund’s asset allocation to fewer stocks and more bonds so the fund becomes more conservative the closer you get to retirement. Fees are relatively low at less than 20% bps.
Asset Allocation for Target Date Retirement Funds
Another option is Vanguard’s Life Strategy Funds which are very similar to their Target Date Retirement Funds.
Life Strategy Funds
As their names suggest, these are simple and often called “lazy” portfolios primarily driven by investing time horizon and to some extend risk tolerance. They usually invest in 4 funds covering U.S stocks, international stocks, U.S. bonds, and international bonds.
If you’re the type of individual that would like to set your investments on autopilot then these funds could be the right fit for you. You’ll be getting a well-diversified portfolio at a very competitive cost.
My Asset Allocation
I consider myself an aggressive investor which basically means that my portfolio is dominated by stocks. If you take a look at the graph below you’ll notice that I’m at 92.3% stocks and 7.7% bonds (tax deferred and taxable accounts only). Income from rental properties is not included but that could be considered as a type of bond.
Do you think this is a crazy portfolio? … Maybe yes, maybe not but regardless it works for me and that’s what matters.
Many experts claim a big market correction is inevitable but who the hell knows what and when things will happen in the future?
If we do end up seeing a big drop in the market it will hurt like a bitch; however, I plan to stay the course without letting my emotions affect my investment strategy.
Remember, time is one of the critical elements of wealth creation and it happens to be on your side especially if you start investing early.
- Do you know what your asset allocation is? If you don’t then I strongly suggest taking the time and finding out what it is.
- Once you do this, ask yourself … do I feel good about it? Should I change/adjust anything?
- If you want to start investing choosing a target date or life strategy fund might be a good choice especially if you’re not a DIY investor.
- You may disagree with my asset allocation and that’s perfectly fine. Just because it works for me does not mean it has to work for you.
- I’m a passive investor who invests for the long haul. Even if there are market corrections time is on my side.
Until next time … JJ