The Perfect Asset Allocation Plan

All too often we make investing far more complicated than it really is. I was guilty of this when I first started investing back in 1993. Like the search for the Holy Grail, I was convinced that there was a perfect asset allocation plan. And I searched for it. I spent hours upon hours trying to construct the perfect investment plan.

I’ve mellowed a bit since then. I’ve ditched my micro cap value fund for a much simpler asset allocation. It’s not that a micro cap fund, a China ETF, or mortgage REITs are bad investments. Rather, I’m no longer convinced that such asset classes are necessary to achieve my investment goals. I’m also not convinced such a complicated portfolio will outperform a simpler approach.

This Philosophy informs my responses when I receive email from readers about their own investments. They want to know if they should have a small cap value fund, or REITs, or a dividend fund, or dozens of other asset classes in their investment portfolio. This article and podcast is in response to all of those questions and similar emails I'll certainly receive in the future.

How the Pros See Asset Allocation

There are a number of excellent sources we can turn to for investment ideas. Here are four of them.

Target Date Retirement Funds

The major mutual fund companies offer target date retirement funds. These fund of funds as they are called, split the amount of your investments into several mutual funds. Reviewing exactly which funds these target date investments to use give us insight into the asset allocation chosen by the likes of Fidelity.

Robo Advisors

Much like target date retirement funds, we can also peer into the asset allocation plans of automated investment services. Three of the most popular are Betterment, Wealthfront, and Future Advisors. Wealthfront, for example, has an excellent white paper on its investment philosophy. It not only shows its asset allocation plans for taxable and retirement accounts, but it also provides an in depth explanation for the asset classes it has chosen.

Investment Books

Any number of investment books provide excellent ideas on asset allocation plans. Two of my favorites are All About Asset Allocation by Ric Ferri and Unconventional Success by David Swenson. I interviewed Ric about his investment philosophy in Podcast 3. I’ve written about David Swenson’s model asset allocation plan as well. Both are worth reviewing.

Bogleheads Forum

The Bogleheads Forum has a wealth of information about investing. Of particular interest to asset allocation plans is what they call Lazy Portfolios. That resource lists a number of asset allocation plans that are easy to implement and maintain. It’s a great resource.

Same Kind of Different as Me

What's interesting about the above resources is that none of the asset allocation plans is identical. While some are similar, they all take a slightly different approach. So much for the "perfect" asset allocation plan. It doesn't exist.

As I was pursuing the Bogleheads forum while writing this article, I came across the following comment:

The longer I’ve invested, the more I’ve come around to the view that most portfolio decisions just don’t matter. Find some way to own a reasonably large number of stocks from a reasonably large number of industries. Have some bonds or cash or something that will help you get through the lean years. That’s good enough. Stay the course and you’ll get satisfactory returns. Spitball the rest.
— https://www.bogleheads.org/forum/viewtopic.php?f=10&t=171556&newpost=2591132

I couldn't say it better myself.

Alternatives to Stocks

In fact, it’s worth mentioning that plenty of investors look for alternatives to stocks to further diversify their portfolio and have a little fun with their investing, while still growing their nest egg.

For example, Masterworks is an investment platform that lets you buy shares in blue-chip artworks: Pieces by household names like Andy Warhol. The blue-chip art index has outperformed the S&P 500 over the last 18 years, making blockbuster art a quirky but potentially lucrative addition to your personal portfolio. Find out more about Masterworks in our full review.

Of course, all of this raises an important question. How do we choose the asset allocation plan that is best for us?

Related:

The Perfect Asset Allocation Plan for You

Given that there is no one "right" investment plan, the key is to find a solid plan that fits your personality and investment options. You can start with any of the asset allocation models listed above, and then customize it to fit your investing style. To do that, consider these four factors:

Risk Tolerance: The starting point is to understand how much volatility you can handle. This comes with experience. As you start to invest, you typically don't have a lot of money invested. As a result, losing 50% (the 2007-2009 market dropped 57%) seems awful, but the actual dollar loss may not be much. If you have $1 million invested, losing 50% can be traumatic.
Complexity: I know some investors that embrace complexity. Their portfolios have literally dozens of asset classes. They don’t invest in one or two international funds, they invest in country-specific ETFs and slice the U.S. market into six or more asset classes. It’s a lot to manage, particularly when it comes time to rebalance. If that kind of complexity is not your cup of tea, keep your portfolio simple. It’s more than reasonable to build a well-diversified portfolio with just three or four asset classes.
Boredom: Some would be bored with a 3-fund portfolio. They aren't interested in a wildly complex portfolio, but they do want some exposure to additional asset classes. These often include REITs, small cap, and emerging markets. If that's you, and it's certainly me, expand your portfolio to cover one or more of these asset classes. The key is to find a plan you'll stick with in good times and bad.
Investing Options: Finally, we have to work with the investing options available to us, particularly in a 401k or other workplace retirement plan.