Select the asset allocation mixture on your investments carefully prior to investing. This means understanding the risks that are involved (primarily market risk and inflation risk). Educate yourself on the matter through independent experts who teach instead of sell. Once you know what the right allocation is for you (be aware this can and usually does change over time as you age and get closer to withdrawing money), set it and leave it alone. You will want to answer these questions:
Read All About Asset Allocation, by Rick Ferri. This book will provide you a good foundation of knowledge that will help you with this very important decision. Asset allocation is a pretty simple concept, once you become educated on the matter and understand how to separate your investments in a cohesive and understandable way. Your asset allocation should work hand-in-hand with your financial plan that contains your short- and long-term goals. Vast diversification at the lowest possible cost is the goal using a passive approach with index funds or ETFs. YOU can do it!
John Bogle, author of The Little Book of Common Sense Investing and Common Sense on Mutual Funds provides a simple approach to this issue. Use your age to identify what your bonds and cash allocation should be. If you were 35, you would have 35% of your investments in bonds and cash and 65% of your investments in stocks. This seems a bit too bond heavy to me, but Mr. Bogle was a very wise and experienced man. He would admit that this is a pretty conservative allocation, but he would also tell you that many people are not as risk averse as they think. Know thyself!
Read The Four Pillars of Investing by William Bernstein. This book is for the person who has read many books on investing and is ready to learn at a deeper level. Bernstein does a beautiful job of helping you understand the theory behind investing, the history of markets, the pychology that is involved and finally, how the financial services industry works. When you are done with this book, your level of knowledge will far surpass the vast majority of investors in the world, to include the folks who work in the industry. The Investor's Manifesto is a condensed version of this book if you prefer that route.
Once you have selected your asset allocation, place that money in no-load index mutual funds. You can find a list of recommended funds on this website. Once you become truly educated on investing and discard your ego, you will see the wisdom of investing in these types of funds that diversify you all over the world at the lowest possible cost. Could you do it with ETFs? Sure, but the goal is to buy and hold and for many, ETFs cause more buying and selling. I prefer a few index funds as you automatically reinvest the yearly income. Keep it simple.
Purchase your funds, allocate them appropriately, (diversified all over the world) and then leave them alone. Leaving them alone is very, very important. Your asset allocation model is not to be touched until it is time to rebalance them. This means no timing the market. No listening to the TV pundits. And, definitely don’t listen to Billy Bob in the break room at work. None of the advice these “experts” spew out is worth a hill of beans. Stick to your plan and stay the course!
Rebalance your investments no more often than once a year. This simply means you go in and sell some bonds or stocks to get you back to your designated allocation. You can also do this by simply adding more money to different accounts throughout the year. If you are in the withdrawal stage, you can rebalance by selling your winners. You should avoid selling in taxable accounts because of the tax consequences. Focus on your company retirement plan and your Roth IRA when rebalancing.
Here is an example using a $300,000 Portfolio with a desired asset allocation of 90%, 80%, 70%, or 60% in stocks. You would want to keep the Real Estate, Small-Cap Value and Bonds (if possible) in retirement accounts because they are not tax efficient (tax efficiency = low turnover and minimal yearly income to include capital gains). The other funds could be kept in a non-retirement brokerage and/or a retirement account because they are quite tax efficient. The goal is to be efficient with your allocations, fees, and taxes all along the way.
90% stock allocation
Stocks = $270,000 = 90% of the portfolio
50% / Total Stock Market Index Fund (VTSAX) = $135,000 at .04% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $27,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $27,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $27,000 at .16% expense ratio
10% / Small-Cap Value Index Fund (VSIAX) = $27,000 at .07% expense ratio
10% / Real Estate Index Fund (VGSLX) = $27,000 at .12% expense ratio
Bonds = $30,000 = 10% of the portfolio
66% / Total Bond Market Index Fund (VBTLX) = $20,000 at .05% expense ratio
33% / Short-Term Bond Index Fund (VBIRX) = $10,000 at 07% expense ratio
80% stock allocation
Stocks = $240,000 = 80% of the portfolio
50% / Total Stock Market Index Fund (VTSAX) = $120,000 at .04% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $24,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $24,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $24,000 at .16% expense ratio
10% / Small-Cap Value Index Fund (VSIAX) = $24,000 at .07% expense ratio
10% / Real Estate Index Fund (VGSLX) = $24,000 at .12% expense ratio
Bonds = $60,000 = 20% of the portfolio
66% / Total Bond Market Index Fund (VBTLX) = $40,000 at .05% expense ratio
33% / Short-Term Bond Index Fund (VBIRX) = $20,000 at 07% expense ratio
70% stock allocation
Stocks = $210,000 = 70% of the portfolio
50% / Total Stock Market Index Fund (VTSAX) = $105,000 at .04% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $21,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $21,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $21,000 at .16% expense ratio
10% / Small-Cap Value Index Fund (VSIAX) = $21,000 at .07% expense ratio
10% / Real Estate Index Fund (VGSAX) = $21,000 at .12% expense ratio
Bonds = $90,000 = 30% of the portfolio
66% / Total Bond Market Index Fund (VBTLX) = $60,000 at .05% expense ratio
33% / Short-Term Bond Index Fund (VBIRX) = $30,000 at 07% expense ratio
60% stock allocation
Stocks = $180,000 = 60% of the portfolio
50% / Total Stock Market Index Fund (VTSAX) = $90,000 at .04% expense ratio
10% / Developed Markets Index Fund (VTMGX) = $18,000 at .07% expense ratio
10% / Emerging Markets Stock Index Fund (VEMAX) = $18,000 at .14% expense ratio
10% / FTSE All-World ex-Small-Capital Index Fund (VFSAX) = $18,000 at .16% expense ratio
10% / Small-Cap Value Index Fund (VSIAX) = $18,000 at .07% expense ratio
10% / Real Estate Index Fund (VGSAX) = $18,000 at .12% expense ratio
Bonds = $120,000 = 40% of the portfolio
66% / Total Bond Market Index Fund (VBTLX) = $80,000 at .05% expense ratio
33% / Short-Term Bond Index Fund (VBIRX) = $40,000 at 07% expense ratio
See the most current return averages based on allocation models.
Click Here*Link provides historical averages only. They will not tell you what your return will do in any given year. What it will do is help you see how different asset allocation models compare over the years based on how many stocks or bonds and cash you have in your portfolio. Use this as an educational tool to further your understanding of asset allocation.
