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Day 14 - Asset Allocation

By JLP | March 8, 2006

Asset Allocation really isn’t that hard to understand. For most people, asset allocation is how their investments are divided up between stocks and bonds. I hate this phrase because it is so worn out, but when it comes to your investments: don’t put all your eggs in one basket. Having a proper asset allocation plan will keep you from doing that.

The simplest form of asset allocation would be 50% in stocks and 50% in bonds. However, asset allocation can get much more detailed than that. For instance, one could decide to invest the stocks portion of the portfolio in small cap stocks, large cap stocks, growth stocks, value stocks, international stocks, dividend-paying stocks. You get the picture, right? So, a person could have ALL their money invested in stocks and still be considered diversified, just not as diversified as other people may be.

So, what is a proper asset allocation? Of course along with everything else in personal finance, there is no right answer. Your asset allocation depends on YOUR needs and risk tolerance. Although some people would say I’m nuts, I have all of my wife’s 401(k) money in stocks. Eventually, I will move some money over to bonds, but for right now, I’m keeping our allocation 100% in stocks. The authors of The Bogleheads’ Guide to Investing state that John Bogle recommends investors should have a percentage of bonds that matches their age. So, since I’m 36, I should have 36% of my money in bonds. As you can probably imagine, that seems a bit much to me. However, for you that might be a good rule of thumb.

I have written quite a bit about asset allocation in the past. For a good primer on what asset allocation is and how to compute the return for a portfolio, check out my post What the Heck is Asset Allocation. For information on how to rebalance your 401(k), read Time to Rebalance Your 401(k).

For more on asset allocation, check out what these bloggers have to say:

The Real Returns:

Balanced Funds

FreeMoneyFinance:

4 Rules for Asset Allocation

FiveCentNickel:

Rebalancing our Retirement Portfolio

MyMoneyBlog:

Evaluating
My Parent’s 401k Portfolio, Part 1

MusingMoney:

Allocation

Topics: Asset Allocation, Investing |

Comments to “Day 14 - Asset Allocation”

SingleMom Says:
March 8th, 2006 at 1:45 pm

This post is right on the money for me.

You’re not nuts (lol)! Like you said, it depends on your tolerance
for risk. My 401k is 90% in stocks. I figured I’m young so what the hey.
I do need to read/learn more about asset allocation so I can make a
more educated decision in the future.

BTW, I’d love it if you could stop by my blog and comment on my post
for today.

Thanks!

Suresh Says:
March 9th, 2006 at 3:01 pm

JLP, I don’t pretend to know the nature of your all equity portfolio. But, speaking generally, an all equity portfolio comprising an S&P 500 index fund worked terrifically in a secular equity bull market, such as we saw from 1982-2000. Query whether such an all equity portfolio will perform as well in a secular bear market in equities, which I suggest to you we are in.

Check out the following article from the Journal of Financial Planners:
Understanding Secular Bear Markets: Concerns and Strategies for Financial Planners (http://www.fpanet.org/journal/articles/2006_Issues/jfp0306-art7.cfm)
…
If financial planners are to consider the possibility that we are now experiencing a secular bear market, then they might want to consider some investment strategies that have the potential of generating better-than-benchmark returns in an environment of falling P/E ratios and flat to falling equity values. This article will now introduce four potentially viable active investment strategies as an alternative to passive strategic asset allocation, and address a few of the practical issues about how they might be implemented.
…
The key point of this article is that relying solely on a passive strategic portfolio designed to produce near-benchmark returns in a secular bear market will do nothing but guarantee that clients will underperform long-term expectations for an extended period of time and make it likely that they will fail to achieve their financial planning goals. In a secular bull market, like the period from 1982 to 2000, active investment strategies were not necessary to achieve goals—benchmark returns were more than adequate to achieve the desired and required long-term rates of return. In a secular bear market, however, employing active investment strategies like the ones discussed here, in combination with other financial planning recommendations, may be the only route by which clients can actually succeed.

JLP, I’ll admit that the approaches discussed in this article may not be readily implemented in a 401(k) plan, but they may be in one’s IRAs or taxable accounts. With my own IRA and brokerage account, I prefer sector rotation based on my economic outlook to use the article’s terminology.

All the best to you.

All Things Financial - Personal Finances Primer at the Money & Investing Dogberry Patch Says:
April 7th, 2006 at 4:08 am

[...] JLP at All Things Financial blog has recently started a series of 24 posts discussing the basics of personal finance. In each post he introduces the topic with a short discussion and then links to related posts by other bloggers. [...]

Financial Freedumb - Sometimes it takes a little bit of dumb to achieve financial freedom. » Major Asset Reallocation, But Where? Says:
July 27th, 2006 at 3:19 am

[...] You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. 2 Responses to “Major Asset Reallocation, ButWhere?” 1 TADollar says: March 8th, 2006 at 12:29 pm [...]

Tony Says:
October 20th, 2006 at 9:11 pm

Asset alocation is working for me, but I departed from it at the end of April when my equity allocation went from 79% at the start of the year to 40% on May 1. The allocation was very aggressive for a 65-year-old retiree. I sold more in June and July during market rallies. By the end of July stock funds were now down to 18%. In addition to small cap and big cap value funds I also lightened up on GM & GMAC junk bonds and added to my investment grade bonds by buying AAA and AA exchange traded debt issues that were mainly utilities and financial companies. These preferreds have done quite well. I’m very pleased with my total portfolio performance. Yesterday my year to date gain was 11.5%, which surpassed the S&P 500 and achieved it with far less risk. Today I sold a REIT ETF after it had gone up 30%. This is my best performer so far this year. As an aside, I actually converted the Vanguard REIT fund to its ETF equivalent for $50 and by doing so avoided the 1% redemption fee ($510 that Vanguard would have charged had I sold it as a fund before the 12 month redemption period. Now my portfolio is 77% cash (money market and Stable value funds) and my equity exposure is down to 6% while the GM and GMAC junk bonds are also 6%. What I have done it give up the opportunity to obtain more than 12% for the year by taking profits along the way. I’ll be very happy to end the year with a 12% gain. Quite frankly, I’m concerned that the negative correlation that existed among the asset classes may lessen next year so I may start the next year mainly in cash. If I had split the allocation 60/40 with stocks and bonds the results would not have been yielded close to 8%. So I’m very pleased with my performance.

Andrew Says:
October 31st, 2006 at 7:11 pm

Readed

The computer revolution is over. The computers won.

Tony Says:
November 10th, 2006 at 11:24 pm

On October 20 I posted that my YTD return was 11.5%. Today on November 10 I reached my goal of 12%. Next week I’ll sell more of the little stock funds that I have left to lock in this return. I’ll stay in cash until December 30 when I’ll rebalance for the next year. I made a lot of mistakes this year in selling too soon, nevertheless, I’m happy with reaching my goal. One change I’m making for next year is to have fewer funds, but no more than 10% in any one.Good luck to all.

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Day 14 - Asset Allocation