Further Adventures in Asset Allocation

After I had decided on the basics of our asset allocation, there were stilll some further choices to be made. First, within the 60% we were allocating to equities, those stocks can be divided into domestic and international funds. Diversifying outside the bounds of the U.S. shields our portfolio from the risk of having all the eggs in one basket. If the U.S/international split was based purely on market capitalization, it would be close to 50/50. But with my American exceptionalism hat on, I decided to weight the U.S. at 60% of the total stock allocation, leaving 40% for international.

Further, since past data (which provides no guarantee of future behavior!) shows that stocks of small companies, particularly those that are undervalued vs. their inherent value, perform a bit better than the overall market. So out of the U.S. and international pie slices, a small bit of each is reserved for indices which track small capitalization, under-valued companies.

Finally, within the bond portion of the asset pie, I split half and half between a fund tracking the full bond market, and one that includes inflation protection (TIPS). TIPS provide a lower rate of return than normal bonds, but since the return is guaranteed to be on top of inflation, they provide additional diversification and protection.

Now, all of that adds up to quite a few pie slices. I didn’t quite round the numbers exactly, but the following chart shows the general idea.


Next, the difficult portion was to find funds available in the various retirement accounts that my wife and I had accumulated. They all had different lists of available funds, so it took quite a while to work everything out. I use a modified version of an Excel spreadsheet from the Bogleheads site to check how everything adds up. When there were multiple options for a given asset type, I chose the fund with the lowest operating expense, which usually ended up being either Vanguard or Fidelity Spartan funds.

All told, we ended up with 18 different funds. Crazy, I know! That’s what we get for having nine different accounts with three different firms! At the moment, 12 of the 18 constitute less than about 5% of our total each.allocation2.png

So there it is. Most of the information I’ve read recommends rebalancing no more than maybe twice a year. Rebalancing is the process of comparing your current asset allocation against your target and then shifting funds to bring yourself back into alignment. You don’t want to do it too often, or you lose out on investment gains. But do it too sparingly and you don’t get as much risk protections from the diversification.

Too many numbers. I know myself to be a spreadsheet junkie, so it was somewhat enjoyable. But now I get the benefit of knowing that our retirement funds are balanced against risk and that I don’t have to bother to check the market very often. Our target asset allocation is set, and we’ll ride this for at least five years or so, when it may be time to adjust the percentages due to age.

Asset Allocation

When I got married last year, one of the inevitable chores was consolidating financial accounts. As it turns out, my wife and I have similar approaches to budgeting and saving, so our discussions about family spending was relatively easy. However, the shear number of accounts that the two of us held required a good bit of shuffling and closing. We each held checking accounts with both online banks and local banks, primarily in order to have a non-zero interest rate while still retaining access to local ATMs. In addition, because of vagaries with our employers, together we had close to 10 retirement accounts.

After working through the relatively easy task of choosing which bank accounts to keep and which to merge, I was left looking at the bulk of our retirement savings (which was not a lot of money itself, just a lot of accounts) and wondering how to have a coherent management approach.

So after doing some reading, I finally figured out that what I was working on was Asset Allocation. There is no shortage of information, ranging from short definitions and somewhat abstract explanations to straight-forward steps. The best overall description probably comes from the Bogleheads site.

I checked out a few books from the library and found Larry Swedloe’s book on investment strategy to be rather informative. That book was one of the primary ones that convinced me to actually put some thought into which stocks and mutual funds we were choosing as investments with our limited retirement savings.

I found a series of posts from the blog, My Money Blog, to be extremely helpful. Ultimately, I decided to get out of the stock-picking game and move completely to passive investing when our savings went into a number of index funds, rather than actively-managed mutual funds. I wish I could go back to the 25-year self and tell him to stop thinking he was smarter than the rest of the people picking stocks and just invest in index funds instead. Even with the low market returns from the past decade, I think I would still come out better with indexing than picking.

The first decision was how much of the portfolio should go to bonds vs. stocks. I ended up going with 30% bonds, but in hindsight, I’m beginning to think that might be a bit too conservative, given the fact that I’m 36 and my wife is a good bit younger. In any event, here’s how our allocation looks.allocation.png

The two smaller wedges are for commodities and real estate. In our retirement accounts, we have access to a fund that invests in real estate as well as an ETF for commodities. And based on the theory of using different asset classes to reduce risk, I decided to stick 5% in both.

More later about applying a comprehensive portfolio allocation among all of our retirement accounts. I’m a numbers junkie and getting to mess around with Excel has been fun. it’s not like we’re Bill Gates and shifting millions of dollars around, but with our employers contributing to our retirement, we need to make wise decisions about how to plan for our eventual hazy days of retirement!

(I’m writing this post largely because I’ve gained so much knowledge from many of the financial bloggers out there. I wanted to contribute a small bit of feedback.)