How to Achieve the Right Asset Allocation

by Sheldon Jacobs

How To Achieve The Right Asset Allocation Splash image

It has been my observation that most investors focus on one aspect of investing more than any other—the recommendation, and by that I mean specific security advice.

That is because investors have been trained by brokers and the media from time immemorial to believe that recommendations are the primary road to investing success.

Yes, recommendations are important, but contrary to most people’s belief, they are only the final step in the investing process. Recommendations are less important than the proper asset allocation and diversification decisions that necessarily precede them. This article discusses these first two far more important steps.

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Sheldon Jacobs is founding editor and publisher of The No-Load Fund Investor newsletter. He is author of “Investing Without Wall Street” (John Wiley & Sons, 2012).


Discussion

Dave from California posted about 1 year ago:

Overall, a very good article and sound advice. However, the author contradicts himself about whether sub-allocation or picking individual funds is more important. Two contradictory statements may indicate his ambivalence on this point:

"...determining sub-asset allocations is far less important than determining asset allocations—and probably even less important than selecting individual stocks or funds."

"In sum, put more effort into getting the right asset allocation and second-tier diversification, and less effort in picking individual funds and stocks."


Gordon from North Carolina posted about 1 year ago:

As a Boglehead (follower of John Bogle; Bogleheads.org) and a Vanguard investor, I would say I very much agree with his premise and he presents good evidence.
I have heard Sheldon Jacobs speak several times....very impressive.


Robert from Massachusetts posted about 1 year ago:

No matter how sophisticated you are, it's always good to step back and rethink the basics. Sometimes those get lost in the heat of battle. This was a good article.


Charles from California posted about 1 year ago:

I followed Mr. Jacobs from the mid-90's until the mid-2000's through his No-Load Fund Investor Newsletter. Although I have become a Vanguard passive investor, I still refer to his book and advice often.


Joseph from Minnesota posted about 1 year ago:

If you have a just little to invest or you're a novice investor this is a good primer. That said this is a model for the world of the 1970's through the 1990's, where normal business cycles, good balance sheets and earnings growth were the primary factors that determined investment success. One could diversify across and within these asset classes with occasional rebalancing, regularly dollar cost average, and sleep well.

Then came the dark pools, derivatives and uber-leverage. And in 2008 it all came crashing down. The old allocation was an unqualified disaster with no place to hide but cash. And now even cash is a negative real return.

Today markets are tossed about by the actions of politicians and central bankers who are busy debasing their currencies to save their banks at the expense of savers and individual investors. A much more robust line of defense required. Against all this, diversification calls for a position in gold, funds that offer uncorrelated hedging strategies or access to private equiry, timber, a splash of REITS. If you're lucky you'le lose money on the gold and hedging, and make money over the long term on the rest.


Fred from New Jersey posted about 1 year ago:

Great article.I will now Bogle my strategies,playing the whole market more aggressively with some small cap indices and just pick the remainder.I see a 65%whole markets 35% pickem


Richard from Kansas posted about 1 year ago:

Excellent article. I invest with Vanguard and work with one of their CFPs once a year. I was interested in the advice about small caps. Although there is the market average of small caps within the Total Stock Index which I use, I will add some more small caps via the small cap index. My biggest puzzler is the large amount of I-Bonds I hold which are 40% of my bond allocation, purchased in 2001 which have a 3% base and are currently drawing 6.1% interest tax protected and totally safe. I'm 75 and still working some and so is my wife. I will obviously at some point need to be cashing some of these I-Bonds in and will owe taxes on each portion cashed. Maybe nice problem to have but still something I need to address.


Robert from Massachusetts posted about 1 year ago:

I like the article and agree it is aligned with the Vanguard philosophy and recommendations from their CFP's. However, I think their CFP's would say you should not "over-weight" the small-caps above market composition ("I would bring the small-cap weighting up to 20% of your domestic stock portfolio").

A question I have is should your mix of taxable vs. tax-sheltered accounts influence your allocation? If you happen to have a large percentage of your assets in tax-sheltered acounts (e.g. 50%) should you be more open to other asset classes such as REIT's which are lower in correlation but very tax-inefficient unless you can keep them in a tax-sheltered account?


Barry from Alabama posted about 1 year ago:

very good review and one of the better articles discussing diversification.


Dave from Washington posted about 1 year ago:

This is a very excellent article.

To the poster who thinks this is a model that only worked well in previous "days gone by" you only need to look at the returns of a Total Market Index, like VTSMX, over the last couple years. Even just owning this one fund for beginning investors has out performed the majority of the professionals.

I have put Sheldon's "Investing Without Wall Street" on my Wish List.

Thanks!


Dave from Washington posted about 1 year ago:

Robert,
I enjoy putting REIT's in a Roth account, or other assets weighted on the high end of the risk / return spectrum.

In an IRA type account, not so much since you have to realize that 1/4 or more of the income / profit is going to the "taxman" in most cases.


Malcolm Field from California posted about 1 year ago:

An outstanding paper. Mr. Jacobs names pairs of equity funds. I would be interested in his choice of long, intermediate and short term bond funds.


James Pace from Utah posted about 1 year ago:

My broker and I have always been afraid of buying bond funds. my experience with them has not been good. I have partially addressed the issue by heavily waiting my investments with the Vanguard Wellesley fund which is 60% bonds and the Vanguard Wellington fund which invests 40% in bonds. These two funds have really helped when the market goes south. I would like to see your opinion on bond diversification.


Robert Jarvis from Georgia posted 8 months ago:

Good coverage for stocks, but what about the fixed income side of the equation?


Steven Stark from Idaho posted 8 months ago:

My e-mails from Zacks always states we are in a secular bull market. Author says we are not.
Are we?


Ralph Nelson from Texas posted 8 months ago:

I am going to make a comment, but I would really appreciate a reasoned response. It seems to me of little value to consider a 50-50 equity/bond allocation over the last 15 years, or even 30 years. That is an environment I will never see again in my lifetime. Long term bond interest fell somewhat steadily over the in time period producing nice capital gains on the bond side to add to a rising stock market. We can't get that now over the next 15-30 years with bond rates starting from present lows. So, it seems to me, asset allocations which refer to the last 15-30 years are of little value in the asset allocation decision now. The only value I see in bonds now is reduction in volatility and then only if you keep your durations short. What to do. I really don't know


Lyon Steadman from Colorado posted 7 months ago:

I thought this was a great article as well. Here are some questions with what is going on now in the markets for any one who cares to answer. Given you are in the retirement category of needing a 50/50 asset allocation because you are close to retirement, how does one deal with the current market place because it appears that bond interest will be increasing in the near future, which could decimate the value of a bond portfolio? Thoughts??


Charles Rotblut from Illinois posted 7 months ago:

Ron and Lyon,

Though bond yields are still historically low, even after the recent spike, nobody knows how much yields will rise in the future or when.

Over the long-term, bonds have realized different return characteristics than stocks. Individual bonds, when held to maturity, provide preservation of capital--something stocks do not. Bond funds may fall in price, but they will adjust with higher yields.

Then there is the volatility of future stock prices. When the next bear market occurs, how much of an allocation to equities will you be able to emotionally and financially tolerate? It is a very important question to consider.

-Charles


Charles Rotblut from Illinois posted 7 months ago:

Steven,

We rarely know if we are in a secular bull or a secular bear market until we are far into the cycle. This is why is important to stick with a long-term allocation strategy.

-Charles


J. D. Polsky from Nebraska posted about 1 month ago:

Hi, Shelly, It's Don. You forgot to include a very important category, LOSERS.
I'm in Omaha but I bet your in FL I'm moving to CA. Regards


Dennis Costarakis from Nevada posted about 1 month ago:

I disagree with the concept of asset allocation. Investing is about taking risks. If all you want to do is outperform the S&P500, you need to find an S&P500 etf with an anomaly that can't be arbitraged away. An example is the equal weighted S&P500 ETF (symbol RSP)which outperforms the S&P500 ETF (symbol SPY)regularly. The RSP has compounded at over 10% since inception ten years ago.

There are rule based strategies that ignore asset allocation and that do better than the RSP. Just look at the various strategies in SIPRO.


Robert Kinne from Colorado posted about 1 month ago:

Whenever one consults a financial advisor, one hears about "asset allocation", which always seems to mean putting money in the stock market and bond market, with the percentage of bonds increasing with age. This is apparently taught in FA101 as the basis of all planning. We always see statistics that "prove" the benefits of large bond allocations.
What happened from 1990 to 2005 is interesting, but to contend that the future will be just like the past is a fundamental error. Those with large bond allocations in the last 10 years at least may have noticed that bonds aren't doing so well, and it doesn't appear the short term prospects are good. The people who suffered the most are those who pulled their money out of stocks at the bottom of the 2008-9 crash and put it into bonds.
Just a thought - true "asset allocation" would consider something other than stocks and bonds, which many of us have concluded are unduly controlled by Wall Street and a relatively few "experts." Maybe real estate, commodities, or putting some investment into backing small businesses would prove useful. That would be real diversification, not the stock/bond/cash percentages preached by every financial advisor around. just sayin'


Steve Daniels from Connecticut posted about 1 month ago:

Charles

While I think highly of Mr. Jacobs and agree with much of what he says, I'd like to point out that he has omitted many asset classes that would address the high correlations issue he correctly stated. There are a number of asset classes that perform like the S&P but don't correlate highly with it. Some of these include Managed Futures, long/short strategies, commodities and other alternative investments. These need to be included in a properly diversified portfolio to my way of thinking.


Peter Rukavena from New York posted about 1 month ago:

I also agree with much of what Mr.Jacob says in most part.

However during significant market corrections the correlation factor in almost is all asset classes increases dramatically.

It is not very easy to identify the assets classes that have low correlation in big corrections because most of them experience wild swings in correlation factor.


Zehrbach from Iowa posted about 1 month ago:

Interesting article. After considering correlation, need to look at accrued gains related to the small differences in correlation. Compare the growth lines of RFG( Mid Growth) and Value) and RZV ( Small Value over last 3 and 5 years. They beat the large cap and index funds in most cases. With correlations of 90 or so. Its the little things that count.
Also, check preferred stock. You can get much greater gains from preferred stocks with only a little more risk than bonds. This provides a base with gains.


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