Asset allocation is defined as “the strategy of dividing your investment portfolio across various asset classes like stocks, bonds and money market securities.” (investopedia.com)
Find your latest statement that your adviser or investment company has sent you. Somewhere in the paperwork, that most likely has no mention of how much in fees you’re paying, you will find an investment summary and a pie chart that a sixth grader could come up with. A list of asset classes/ investment options will be laid out in front of you with the percentages of your money that is in each one. This my friend is the asset allocation that your adviser has either personally come up with or plugged numbers in on an already determined model from the investment firm. The asset classes will look something like this:
Balanced (usually Target Date Funds)
Fixed Income (bonds)
Other/miscellaneous (REITs etc.)
You may find your money in several different asset classes, several mutual funds within each class, and many of them actively managed funds… LUDICROUS! We have already established that Index Funds are your best bet when compared to actively managed funds and the expense ratios are significantly lower. Never fear with the click of a mouse you can get your asset allocation under control and to your liking.
So what should your asset allocation look like. After looking at an in-laws investment advisers laughable “risk questionnaire” your score would determine one of five strategies; conservative, conservative-moderate, moderate, moderate-aggressive, or aggressive. Clear as mud? Good, because there is an easy rule of thumb way to start looking at where you should be. It’s called the rule of 100.
We have already established that Stocks = risk (reward) and Bonds = less risk (less volatile/ safer). The rule of 100 goes something like this… 100 minus your age equals your base asset allocation. So, for a 30 year old, 100 – 30 = 70. The sum equals your stock exposure and your age as bonds (i.e. own your age in bonds).
30 year old Asset allocation: 70% in stocks/ 30% in bonds
Through the readings and research that I have done the rule of 100 is a good basis for starting to create an investment plan. Either way if you can read between the lines; the younger you are the riskier you want to be. Why? Because you have several years to ride the ups and downs of the stock market and the more risk you take on the more reward. Jack Bogle founder of Vanguard and indexing likes the rule of 100 but he also doesn’t mind another rule (60/40). 60% stocks and 40% bonds. PLEASE read this article, scroll down to Jack Bogle’s asset allocation. If you have the time to read the whole article and the other two investment gurus… yeah they like index funds and pay attention to fees!
So what is my asset allocation? Well since you asked…
I am invested in 100% stocks. Why? Two reasons:
- I want the greatest return (risk) during my early years of investing (I am 31 years old).
- I have a pension. In law enforcement we have access to a pretty good public servant pension system. If your pension is solvent and in good shape, why not use this as your bond classification? I do. I am vested and will get a payout when that time comes, similar to a great fixed income bond fund!
My asset allocation for my 457b (deferred comp) is as follows:
60% Large Cap – single index fund that fits this category (i.e. S&P 500 Index or Total Stock Market Index)
20% Small Cap – single index fund that fits this category (Small cap Index Fund)
20% International/ Global – single index fund that fits this category (International Index Fund)
This is my idea of the KISS principle… KEEP IT SIMPLE STUPID! Three Index funds. Three low fee Index Funds. Not my co-workers 7, 10, or 15 different actively manged funds totaling 5%, 7%, or 11% fees!
My portfolio fees with these three funds:
457b (deferred comp) plan = 0.97%
Personal Roth IRA with Vanguard = 0.33%
Please do not take this as a dogmatic preaching that you must do it this way or hit the road. Not the case. I have done the research and found what works for me. Find what works for you and will allow you to sleep at night! Formulate a plan and execute it! More importantly stick to your plan. At the end of your investing career you will be happy you did!
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