I’ll have you recall that I recently wrote about asset allocation strategies and tips. Today I’ll be covering some popular asset allocation models that will be of use to the DIY investor.
There are an infinite number of asset allocation models that you might hear about or find on the internet. They may be good or bad. Everyone has their own preference and it’s up to you to find yours.
For this article, we’re going to look at the portfolios of successful financial professionals and other viable options involving very low cost index investing. I’m not even going to get started on the active vs passive investment debate, because it doesn’t matter for the average investor.
Most people are clueless about forecasted trends, return on equity, or PEG ratios. And why should they care? They shouldn’t. They can get great returns that outperform most (or all) actively managed mutual funds without knowing much at all. It’s called passive index investing, and valid research says it works.
Investing doesn’t have to be difficult, and a solid pragmatic plan can very well get you to riches.
A Few Opening Notes
Before we get started please take note of a couple of things.
I’m going to include the mutual fund fee structure and the ETF fee structure in many portfolios below. You’ll notice that for mutual funds, there are investor shares and admiral shares. Admiral share have lower expense ratios but are only available after the investor reaches a certain dollar threshold. That means you are required to invest $10,000 or more in those mutual funds before the share class switches to admiral, and the annual expense ratio goes down.
This is why I always prefer investing in ETFs. They have the baseline expense ratios with no minimum investment amount. In addition, they are usually more tax efficient that mutual funds.
The (ER) below denotes “Expense Ratio” and is how much the mutual fund company takes in fees. Please note that most actively managed mutual funds take over 1% in fees per year, so you should appreciate the ratios listed below. Fees are probably the most important part of long term investing.
The “tickers” are the sequence of letters, like “VTI.” This is how stocks and mutual funds are traded and tracked on the open market. Google these tickers to get more information.
I’ll list the portfolio’s in order of ease. We’ll start with the most simple on top.
Target Date Retirement Fund
The easiest possible investment option for the DIY investor is a standard target date fund offered by a reputable company like Vanguard. Not surprisingly, these funds have a target date that is meant to represent your estimated retirement age. The holding are reflective of the investors age and are automatically shifted properly over time from stocks to fixed income. And they don’t even charge you for doing the work! The expense ratio is a measly 0.18%.
Let’s look at the one recommended for me. The 2055 fund gives me a 42 year investment horizon which puts me at 65 for the target retirement age. Spot on, except I’ll be financially free at a must younger age! Anyhow, the ticker is (VFFVX) and here are the current holdings. It’s actually a great set up, with solid holdings and an ideal allocation of stocks and bonds. If you want to set it and forget it, think about investing in one of these.
Literally so easy a caveman could do it. And he’d be a rich caveman in 40 years time. It’s very possible to get complete portfolio diversification, and excellent returns, in just 2 Vanguard funds. I’d hold less bonds, and probably just consider the target date fund listed above because the expense ratios are very similar, but this one potentially requires rebalancing and checkups.
Three fund portfolios are commonly quoted by financial professionals and authors as a great starter portfolio. They are almost always three equal parts made up of U.S stocks, international stocks, and bonds. This is a decent option for the investor who is actively learning and just needs to get started. But in my opinion, there are far better options for people who aren’t really interested in investing and those who understand and enjoy investing. The former should just stick their money in a retirement date fund. The latter should throw a few more ETFs in the mix.
Rick Ferri, CFA, is credited with authoring this porfolio as the cornerstone investment portfolio. It adds real estate in the form of REITs to the mix and no longer slices the pie in equal pieces. It is the launch point for most other complex portfolios and is easily modified.
Rick proposes that investors first determine their bond allocation. You might be wondering how to do that. The easiest way is to hold the equivalent of your age in bonds. So at 23, I’d hold 23% of my money in a bond fund. I actually think it’s a little high, but I’m rather risk averse and prefer the growth possibilities of stocks and real estate while I’m young.
With the remaining funds, allocate 60% to US stock, 30% to international and 10% to REIT. For example, for 60/40 and 80/20 portfolios, you would end up with the following:
More Advanced Asset Allocation Models
There are an infinite number of options past the four fund portfolio. It’s all up to you on what you feel comfortable doing. Many long term investors like to either hold more value stocks or more small cap stocks. They have historically provided higher returns than their counterparts. Or you could combine the two and just own 10% of Vanguards small cap value ETF (VBR). Other options include more real estate exposure, emerging markets, commodities, or other more specific investments.
Here are some more examples:
Bill Schultheis’s “Coffeehouse” portfolio
This simple 7-fund portfolio was made popular by Bill Shultheis’ book – The Coffeehouse Investor. He advocates 40% in an intermediate term bond fund and 10% each in various stock funds. This portfolio contains only 10% international stocks, which is much lower than many of the others you’ve seen. Not necessarily right or wrong, just a little less international exposure.
William Bernstein’s “Coward’s” portfolio
William Bernstein is the author of several excellent books including The Intelligent Asset Allocator and The Four Pillars of Investing. He introduced the Coward’s Portfolio in 1996. It’s Cowardly because it’s diversified with a little slice of everything…
You may be wondering what I’m currently holding or what I recommend. Well, I’ll show you. My portfolio looks a lot like the one below, except I’ve lowered my emerging market and mid cap stock holdings by about 5% each. In place, I’ve added 10% REIT exposure. I’m also holding no bonds, although I’m think of adding 5% short term corporate to the mix.
*Much of this info and more can be found on the Boglehead forums. If you’re interested in the investment scene, sign up there and read, read, read.
Now tell me about the asset allocation models that make sense for you!