Target Asset Allocation for Investment Portfolio

Asset allocation (AA) is an important part of portfolio design, and I like pinning down a target asset allocation for personal reference. This helps keep me focused as my portfolio shifts over time and makes it easy to re-balance back. For some educational posts on this topic, please refer to my asset allocation starter guide.

Below is my updated target asset allocation. Here is my target asset allocation from 2008. It’s not dramatically different, but I’ll try to explain the slight changes below. This is just my own AA, and I think everyone should develop their own based on their own beliefs and learning. If you just copy someone else’s without thinking, when things go awry you won’t have the foundation to stick to your guns. I have been strongly influenced by the writings of Jack Bogle, William Bernstein, David Swensen, Rick Ferri, and Larry Swedroe.

Stocks

I separate things out first into stocks and bonds, and then later it’s easy to go 60% stocks/40% bonds and so on. Here’s my stocks-only breakdown:

  • I now do a 50/50 split between US and International stocks. In general, I would like to mimic the overall world investment landscape. On a market cap basis, the US stock market is now about 45% of the world, while everyone else takes up 55%. 50/50 is just simpler, with a slight tilt towards domestic stocks.
  • I consider REITs a separate real estate asset class. I used to put Real Estate under US stocks since I only held US Real Estate Investment Trusts (REITs), but in the future I would be open to investing in foreign real estate as property laws improve and investing costs drop.
  • On the US side, I add some extra small-cap value companies. Historically, adding stocks of smaller companies with value characteristics (as opposed to growth) has improved the returns of portfolios while lowering volatility. There is debate amongst portfolio theories as to why this happened and if it will continue.

    If you buy a “total market” mutual fund or ETF, you’ll already own many of these types of companies (although many will not be held due to their small size relative to the big mega-corporations). I feel this adds a bit of diversification.

  • On the international side, I add a little extra exposure to emerging markets. You may be surprised to know that “emerging” countries like China, Brazil, Korea, India, Russia, and Taiwan already make up 26% of the world’s markets when you remove the US. These are countries that have a greater potential for growth, but also lots of ups and downs. I add a little bit more than market weight for these as well.

Bonds

I try to keep things simple for bonds, partially due to the fact that they are currently a smaller portion of my portfolio.

  • I like a 50/50 split between inflation-linked bonds and nominal bonds. Inflation-protected bonds provide a yield that is guaranteed to be a certain level above inflation. Nominal bonds pay a stated rate that is not adjusted for inflation. I like to balance the benefits of both.
  • Instead of only short-term US Treasuries for nominal bonds, I added some flexibility. I used to invest only in short-term US treasuries, as they provided the best buffer in my portfolio as they were of the highest quality and had a low sensitivity to interest rate fluctuations. Both TIPS and nominal Treasuries did great during the 2009 crash and the subsequent flight-to-quality, but now the yield on Treasuries is just too low in my opinion. There are trillions of dollars from countries and huge institutions around the world that are tucking their money away under the safe Treasury mattress. By venturing into other places they won’t with my tiny portfolio, I feel I can stay relatively safe yet increase my yield significantly. Possibilities include bank CDs, stable value funds, and high-quality municipal bonds.

Want more examples? Here are 8 model portfolios from respected sources, an updated Swensen portfolio, one from PIMCO’s El-Erian, and Ferri’s personal portfolio. Have fun!

Comments

  1. Great Article. I have vanguard traditional IRA account and have Vanguard Total Stock Market Index, Vanguard total international stock market (except US) and Vanguard dividend growth fund opened. I only have these 3 funds and no bond funds because i didn’t have enough funds to open more. I’d like to do the AA like you have up here….i believe once a year is good but how do i actually do it? it might seem like a stupid question but how do you allocate?

    Say for example i have 3000 in each of these 3 above listed funds for total of 9000 account value….Jan 2011 comes around its time for me to do my AA…..at that time, total stock market and dividend growth show appreciation to 3100 and 3200 respectively for instance and international stock market fund shows depreciation to 2800, how do i do the AA? is it by selling shares of total stock market and dividend growth to buy more of international stock fund? (this assumes 33% AA to each). let me know if this is accurate or whether i am on right path? thanks.

  2. Thanks for sharing this insight, great to see how people are mapping out their asset allocation and the though process behind it.

  3. Question – is this allocation for retirement accounts only or does it also include taxable accounts?

  4. if you’re asking me, it is in retirement account

  5. Looks like a good allocation, Jonathan! Though I myself favor a little more toward small companies and value companies in my own stock allocations.

  6. Looks pretty sound. It is a good idea to keep your fixed income short because rates are so low right now. If you went long you could really lose a significant amount of money if rates were to rise. Also, have you ever considered allocating to very high quality corporate bonds when spreads widen out a bit (not now)?

    I can’t get enthusiastic about TIPS right now because the real yields are so low. 10-year TIPS are currently yielding below 1% real. Why not just hold cash for several years, which should also go up with inflation, until TIPS yields become more attractive? You won’t be missing out on very much in the meantime and may even avoid a loss if real yields were to rise.

    Do you have a particular asset location strategy you’d be willing to share?

  7. @Josh – I’m going to put up the actual funds later, and I rebalance ongoing with incoming funds and also once a year. Yes, you could sell 200 of the 3200 and put it in the 2800, or be more exact. If it’s less than a few %, then I don’t bother.

    @Wayne – I view all my investment accounts as one portfolio, both tax-advantaged and taxable.

    @Andy – High quality corporates would be okay. I bought some individual TIPS at nearly 3% real yield and plan on holding those to maturity, but I know how you feel about TIPS in general. I just plan on rebalancing as time goes on, they’ve been on a pretty good run recently and I expect it should cool off.

    Overall tax-efficient location strategy here, but actual holding are coming soon:

    http://www.mymoneyblog.com/arc.....eturn.html

  8. Check out Swedroe’s book on bond allocation. I agree that the yields on short-term treasuries are horrible right now, but that’s not really what that part of your AA is about. As he says, if you’re worried about the yields on this part of your AA, you really should instead think about changing the overall AA proportions to something with more reward/more risk.

    The problem is that too many of the “higher yield” bond types will be closely correlated to what happens in the stock market, reducing the effectiveness of that part of your AA in reducing risk. This leads to sub-optimal performance for a given level of risk.

    Follow my name link to get to his book on Amazon.

    — Steve

  9. I’m not sure I get all the hype about diversifying your portfolio. Investing is simply gambling. Why is investing some money conservatively and some more aggressively better than investing all of your money in something in between? Diversifying your portfolio decreases your chances of disaster, but logically it therefore must also decrease the opposite too…any chances of huge success.

    The top goals should be to reduce fees to a minimum and invest in ways that make sense from a tax standpoint. After that decide what your acceptable risk is and invest accordingly. I think most people invest in a pyshologically pleasing way but not a smart economic one. TIPS for example seem silly to somebody not near retirement. You’d never invest your whole portfolio in something so pathetic, so by what logic does it make sense to invest some of it? I’m just as worried about the money I invest not growing as I am about the market crashing… the risk of not investing aggressively is a risk too although with our recent market history some people forget it.

  10. @Steve Bonds – I agree that reaching for yield can be dangerous, and the benefit of low correlation. However, what if you compare short-term treasuries with a 3 year duration and 0.50% yield and a 3-year bank CD paying 2% APY in a IRA? The risk for both is the same, and with most CDs you can’t even lose principal.

    @Dave – I don’t really understand what you’re saying. On one hand you’re supposed to invest all your money in one single asset, but on the other you’re supposed to decide what your risk is and invest accordingly?

    Diversification between assets is how I adjust my risk. Buying asset classes that have low correlation to each other, so one zigs while the other zags.

    Gambling with the best possible odds to me = investing for the best chance of high returns with lowest risk.

  11. Very interesting article. One thing that people should be aware of is that many of the “total market” funds are weighed more towards the large cap side, so adding some small cap makes a lot of sense. Same with the emerging markets on the international side.

    @Dave: Agree with Johnathan that I don’t understand what you are saying. The point of diversification is that different asset classes move in different directions, so when one does poorly another will do well, thus reducing your risk. Sure it would be great to put all of your money in that one penny stock that turns into the next Google or Microsoft. The problem is that nobody knows what that stock is going to be ahead of time. By diversifying you are covering all of your bases.

    Also investing is not gambling in that when you gamble your expected return is always negative (i.e. the house wins in the long run). Investing in a well diversified portfolio means that your expected return will be positive.

  12. I can live with your stock allocation although I think REITS are junked up (heavy government subsidies) despite steller returns the last 18 months. People on the coasts are still infatuated with real estate (it can never go down mentality) they are too closely correlated with stocks over the long haul and are subject to credit creep. Your bond allocation leaves a lot to be desired. Short term bond funds and TIPs are closely correleated in my view. I believe in indexing for stocks and active management for bonds. A good bond fund over at PIMCO All Asset All Authority would diversify your bond holdings also Templeton Global Bond would be a nice divesifier. US Treasuries also proved themselves during the last meltdown and are a safe haven. Get more creative on the bond side. Find a strategic allocation bond fund and let the manager diversify for you.

  13. @Hogan: “I believe in indexing for stocks and active management for bonds.”

    That’s funny because the case for indexing is actually quite a bit stronger for bonds than it is for stocks! There are even fewer active managers beating bond indexes than stock indexes and by a smaller margin.

    Is it just me, or does anyone else find it strange that we talk about what we “believe in” when it comes to investing? Should it be a matter of belief or a matter of facts? I know we don’t have all the facts since we can’t know the future (and that’s important in investing), but it seems that we have enough facts to make a decision based on reality and not belief.

  14. Jonathon,

    I too have read most of the authors you have mentioned, but it seems that your international exposure is surely higher than nearly any would suggest. I believe, at the high end, international should probably not exceed about 40 percent

  15. Perhaps I should clarify. Yes, diversification is important in that you shouldn’t be invested in one penny stock. But that can be easily accomplished by making your one investment be a target retirement or index fund. I also feel that constantly making minute adjustments to your allocations is like hopping around between roulette wheels at a casino…any change you make is just as likely to screw you over as it is to make you a profit.

    When I’m 85 I’ll have no interest in any of my money being invested in something aggressive. I’ll want it all in something save so it’s there for me. By the same token at the age of 31 I have no interest in any of my long term money being invested in something passive. Worst case scenario is the market implodes and I’m left with the investment in my education and I just start saving again. Much more likely is I’ll wind up retiring a year or two earlier because all of my money was working for me unlike most people.

    I don’t care about zigging and zagging. If stock A is zigging while stock B is zagging, why not just get stock C which over the course of many years will average out to be (A+B)/2 anyway? It’s low maintenance and fee free.

    I’ve got all of my retirement money invested in Vanguard with super low fees in one index fund and one target retirement fund. I don’t give it another thought. Instead I focus my energy on my emergency/nonretirement money which requires a lot more work to get a good rate and avoid high taxes.

  16. @Dave – Your all-in-one Vanguard Target Retirement fund is doing pretty much what I have above. It holds a US broad market fund, International broad market fund, an Emerging Markets fund, and a Bond fund. It depends on the zig-zag between asset classes and rebalances automatically for you. When you near retirement, it also throws in that “pathetic” TIPS fund for you for inflation protection. ;)

    I think these funds can be fine for a lot of people, especially if you value simplicity and low maintenance. The drawback of an all-in-one fund is you can’t stick the bonds only in a tax-deferred place and the stocks in taxable. The taxation of these two asset types is so different, that it can increase your overall return significantly if asset *location* is carefully done. Of course, if all your money is in IRAs and 401ks, then it won’t matter.

  17. @Jack – I agree with your observation that most authors don’t recommend such a high international exposure. Part of that is due to historical performance, but I think that a market weighting is better now that most corporations are multi-national. Half of the earnings from S&P 500 are from abroad, and foreign corporations have a huge presence here. In any case, 50/50 isn’t all that far off from 60/40.

  18. Phil Gorian says:

    I think your stock asset allocation is in the right areas with the foreign growth currently going on. Reits are probably a good long term play with RE market down, especially if you can pick up some decent yield along the way. I would add quality US dividend paying stocks that have a SAFE dividend that’s not going to get cut. Conservative long term muni bonds with a good yield are great if you have the capital to make it worth your while. They would be my preferred bond play right now if your in it for the long haul. Balancing higher risk with safety is always good common sense.

  19. Jonathan – I appreciate you sharing this and the thought process behind it. Could please share the market performance of this portfolio? Also how this strategy would have performed historically?

  20. systemBuilder says:

    This is the same “model portfolio” that was hyped from 1982-2000 during the last bull market. Over the past 10 years, I imagine you are getting 0% on your stocks and maybe 6% on your bonds, for a net income of 3%. Not too great. During a secular bear market, bonds are the new stocks, and stocks are a fool’s investment.

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