Asset Allocation:Need for REIT & Gold in Retirement Acco

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Asset Allocation:Need for REIT & Gold in Retirement Acco

Postby Dodger » Fri Jul 30, 2010 4:09 pm

Long time reader, first time poster. I’m 24 years old, married, and have been investing for about 5 years. I’m wrestling with the asset allocation (AA) in our retirement accounts. Our current AA in Roth IRA and 401(k) is:

US Large Cap- 40% (Vanguard Total Stock Market ETF VTI [.07%], C Fund [S&P 500] in TSP [.028%])
US Small Cap- 15% (VTI, S Fund [Dow Jones US Completion Index] in TSP [.028%])
International (w/o emerging markets)- 22.5% (Dodge and Cox International DODFX [.65% + $12.5/year], I Fund in TSP [.028%])
Emerging Markets- 7.5% (DODFX)
Precious Metals and Minerals- 5% (USAA Precious Metals & Minerals USAGX [1.3%])
REIT- 10% (CGM Realty CGMRX [.93% + $15/year])

My asset weighted expense ratio is 0.31%. Let’s say the total value is $100,000. I have held USAGX and CGMRX for 5 years now and they have performed handsomely (24.82%/year and 11.59%/year respectively) while the rest of the market has struggled. As a true Bogle fan, I do not like the high cost associated with USAGX and the high cost and high turnover (170%) associated with CGMRX. Additionally, CGMRX is not a true REIT fund as it dabbles in other areas like natural resources from time to time. I feel like if I own the whole market with VTI, then I am significantly overweighting real estate and precious metals by holding onto them. Of course, I have directly enjoyed the benefits of the diversification they provide, but as we all know past performance is no indicator of future returns. I also struggle with the idea of holding DODFX (held for 4 years now). It is a great fund as far as managed funds go- relatively low expense ratio, low turnover rate (< 20%), and solid management. It has also performed very well relative to its peers. Since I have access to the I Fund (EAFE Index) through the TSP for only .028%, it’s hard to pay .65% for DODFX. Being a Bogle fan, I know that the key to future success is lowering my costs and I like the idea of being 100% indexed. I have prepared three course of action:

1. Keep the portfolio as is
2. Keep USAGX (not enough $ to buy VG PM fund) and switch from CGMRX to the Vanguard REIT ETF (.13%), get out of DODFX and move all international holdings to the I Fund and VWO
3. Drop precious metals and real estate all together, move out of DODFX, and go with the below portfolio:

US Large Cap- 50% (VTI, C Fund)
US Small Cap- 20% (VTI, S Fund)
International- 22.5% (I Fund)
Emerging Markets- 7.5% (Vanguard Emerging Markets ETF VWO [.27%])

This would bring my asset weighted expense ratio to .07% and would represent an entirely indexed portfolio. I don’t have an interest in bonds yet b/c of our young age and b/c I will be eligible for a generous defined benefit pension if I stay in my current career. I'm interested in hearing the thoughts of some of the smartest people I know.
Last edited by Dodger on Sat Jul 31, 2010 2:52 am, edited 1 time in total.
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Postby steve roy » Fri Jul 30, 2010 4:28 pm

I would cut REITs to 5%, and go with Vanguard's Total International Index (20%) VG International Smallcap ETF (10%).

Add 5% VG domestic small cap (value).
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Postby nimo956 » Fri Jul 30, 2010 5:16 pm

I would suggest holding at least some bonds, around 20% to start. Bonds aren't just for old people, they provide important diversification benefits. Think for a moment why you have divided your asset allocation into total stock, small cap, intl, etc. Why don't you just go 100% emerging markets for the highest expected return? The answer is because the volatility of EM would actually reduce your compounded return. Adding non-correlated asset classes to your portfolio provides stability. Some funds zig when others zag. This lowers the standard deviation of your portfolio performance year on year and increases your compounded return. Rick Ferri has an illustration of this in his book, All About Asset Allocation, although I'm sure someone can find a similar chart online. Among the funds you've selected, all are positively correlated with the total US stock market. Bonds are the only thing that comes closest to being non-correlated. Thus, you would get the greatest benefits of diversification by adding bonds to your portfolio.

Edit:
As an example, look at 2 portfolios (A and B) each with $10k. Portfolio A earns 5% in year 1 and 5% in year 2. After year 2, the total value is $11,025. The simple average is 5% and the compounded return is 5%. Portfolio B earns 20% in year 1 and loses 10% in year 2. After year 2, the total value is $10,800. The simple average is still 5%, but the compounded return is 3.9%. Funds with higher volatility have lower compounded returns.
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Postby chaz » Fri Jul 30, 2010 6:12 pm

Vanguard has a Precious Metals fund with a lower ER than USAA.
Chaz | | “Money is better than poverty, if only for financial reasons." Woody Allen | | http://www.bogleheads.org/wiki/index.php/Main_Page
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Postby Dodger » Sat Jul 31, 2010 4:04 am

Thanks for the advice so far. Steve- I like your advice to trim the REIT holdings. It seems like a good compromise. I did some research on the VG Small Cap International and it looks like about half of the 10 holdings are in mining companies. That could solve my PM&M dilemma. What do others think about this? Chaz I'm tracking the VG PM&M fund, but if I only allocate 5% to it I can't meet the $10K minimum. Nimo, I see your point. I may have to rethink my stance on bonds in my portfolio.
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Postby LH » Sat Jul 31, 2010 8:14 am

When making a portfolio, to me its
1)low correlation
2)return

that one looks for. With that, REITS, seem to fit the bill.
Stocks
Bonds
REITS

All have low correlation to each other expectantly. I would keep REITS at 10 percent long term.

1)REITS have the expected return near stock
2)they have the low correlation in the past with both business stocks and bonds
3)due to mechanism of earnings, rent from land, Real Estate Investment Trusts (REITS) correlations going forward are expected to be different from business returns, and stock returns.

Its return and low correlations expected that are key in a portfolio. REITS are great by those criteria expectantly. Stocks, bonds, land. Simple diversification.

I would go passive indexing entirely if possible. I have never seen anything which points to any sort of scheme/active management beating passive long term in a predictable fashion, after fees, that is available to regular investors.

All I see is evidence to the contrary, that a higher fee active managed product is expected to lose relative to the index going forward. Your active funds, are expected to lose going forward.

Bonds, you should include 10 percent bonds. This is not neccessary per se. I think 100 percent stock is reasonable at 24 and 100K. But if you have 100K, have slice and diced, SV tilts, and such. Well, the glaring lack is lack of bonds. 10 percent is wise.

The main deal is, to get something simple, and then stick with it.

Get something you can live with when things TANK, and when stocks do GREAT. You want to have one all purpose allocation. Humans, when they adjust to current events, expectantly lose relative to buy and hold. you want to gradually increase bonds as you age, in some sort of preplanned fashion as well.

Your portfolio is fine, your main risk is being human, that at some point, you will bail out when the going gets tough, or buy into some faddy type investment when the going gets great.

Do not think in terms of the current market, think in terms of a late 80s, 90s boom market, think in terms of a 73 74 market, etc. etc. Try to find something you can live with in all those markets, because thats the best approximation going forward of whats gonna happen. Humans form thier portfolio according to recent past events, one has to try and divorce oneself from that. Think of the future market as a smear of all those past events, thats what you should make your portfolio in response to, not just the most small recent slice.
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Postby retiredjg » Sat Jul 31, 2010 3:16 pm

First, I think every portfolio, regardless of age, needs at least 20% bonds. This link has a long discussion about why.

A few years ago, Rick Ferri suggested his Core Four Portfolio. It is total stock, total bond, total international and REIT. Since then, small cap international has become easily available, so I'd suggest:
    45 % Total Stock Market (C Fund and S Fund)
    25% International Large Cap (FTSE All World Large VFWIX/VEU - includes emerging markets)
    5% International Small Cap (FTSE All World Small VFSVX/VSS - includes emerging markets)
    5% REIT
    20% bonds (combo F Fund and G Fund)

This gives you a more total "total" international. It removes I Fund from the TSP, making divvying up your percentages easier. You can overweight small cap by changing the ratio of S Fund to C Fund. You could overweight international small cap by jiggling those numbers (it already is a bit of an overweight at 5%). It is ultra low cost and has great lack of correlation. And would be easy to manage (assuming you have the tax-advantaged space.)
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Postby Dodger » Mon Aug 02, 2010 9:43 am

I've come to a tentative decision based on some of your input:

Large US 42%: VTI, C Fund
Small US 18%: VTI, S Fund
Large International 20%: I Fund
Small International 2.5%: VSS
Emerging Markets 7.5%: VWO and VSS
Real Estate 5%: VNQ
Bonds 5%: G Fund (special TSP fund that offers long term rates on short term govt. bonds)

Asset Weighted Expense Ratio: .08% (can't get much lower) and dropping as I get more money in the TSP.

I decided to go with the 120-age for stock:bond ratio. I was 100% in stocks in the fall of '08 and it didn't bother me. I think I have a pretty high risk tolerance and I won't stray from my AA based on market conditions. Thanks for opening my eyes to VSS. I never would have considered that without the advice here. I decided to stick with the I fund b/c of the low expense ratio- .028% v. VEU (.25%). I can save much more there compared to C/S and VTI (.028% v. .07%). VEU's expense ratio bothers me b/c it's pretty much made up of VEA (.15%) and VWO (.27%), so it should have a lower expense ratio.

The best part of this portfolio is that I can feel comfortable knowing that I am investing with my principles: low cost index funds.

It's going to be about a week or so before I start putting the plan into motion, so if anyone else wants to offer some advice feel free.
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Postby stratton » Tue Aug 03, 2010 12:56 am

chaz wrote:Vanguard has a Precious Metals fund with a lower ER than USAA.

You're comparing apples and oranges here. Vanguard's fund comparatively has a lot of "other" stuff besides gold miners. The USAA fund is more of a pure gold miners fund.

A less expensive fund would be the Market Vectors Gold Miners index etf (GDX). It's very liquid with a lot of shares trading daily.

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...and then Buffy staked Edward. The end.
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Postby LH » Fri Aug 06, 2010 7:34 am

Dodger wrote:I've come to a tentative decision based on some of your input:

Large US 42%: VTI, C Fund
Small US 18%: VTI, S Fund
Large International 20%: I Fund
Small International 2.5%: VSS
Emerging Markets 7.5%: VWO and VSS
Real Estate 5%: VNQ
Bonds 5%: G Fund (special TSP fund that offers long term rates on short term govt. bonds)

Asset Weighted Expense Ratio: .08% (can't get much lower) and dropping as I get more money in the TSP.

I decided to go with the 120-age for stock:bond ratio. I was 100% in stocks in the fall of '08 and it didn't bother me. I think I have a pretty high risk tolerance and I won't stray from my AA based on market conditions. Thanks for opening my eyes to VSS. I never would have considered that without the advice here. I decided to stick with the I fund b/c of the low expense ratio- .028% v. VEU (.25%). I can save much more there compared to C/S and VTI (.028% v. .07%). VEU's expense ratio bothers me b/c it's pretty much made up of VEA (.15%) and VWO (.27%), so it should have a lower expense ratio.

The best part of this portfolio is that I can feel comfortable knowing that I am investing with my principles: low cost index funds.

It's going to be about a week or so before I start putting the plan into motion, so if anyone else wants to offer some advice feel free.


looks like a fine allocation.
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