Asset Allocation for 28 year old (Equity/Bond Split)

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Asset Allocation for 28 year old (Equity/Bond Split)

Postby caklim00 » Tue Jul 01, 2008 12:01 pm

I'm interested in hearing what others would do if they were (are) in their late 20s from an asset allocation standpoint between Equity and Bonds.

100/0? (Larry Swedroe upper limit)
90/10?
80/20? (Upper Limit from William Bernstein's Four Pillars book)

This is a question that I am struggeling with as I know I'm about 30 years till retirement, and am moving from an active strategy (how I got introduced in my early 20s to the investing world) to a long term passive strategy.

Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

Thanks for the help.
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Postby NYCPete » Tue Jul 01, 2008 1:08 pm

Hi Caklim,

For what it is worth, I am 28 years old and I am sticking with 110 minus my age in stocks. Here is how I'm broken down:

Target of 82% stocks 18% fixed income.

Equity portion (82% of portfolio)
60% in U.S. total market index fund
30% in Total Int'l market index fund
10% in REIT Index

Fixed Income (18% of portfolio)
100% U.S. Bond Index fund

I chose to include the REIT fund to lower SD, but don't really expect it to increase returns (if it does, great). I've never bothered to see how a portfolio did like this in the past, but tried Simba's spreadsheet and here is what I got:

1972-2006
11.70% CAGR
13.59% SD

Regardless of what this (or any) allocation did in the past, the future is unknown and uncertain.

Best,
Peter

P.S. Full disclosure, this allocation will be drastically changing for me in the coming months as I utilize Vanguard's new Total World Stock Index Fund.
To the extent that a fool knows his foolishness, | He may be deemed wise | A fool who considers himself wise | Is indeed a fool. | | Buddha
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Postby mike_slc » Tue Jul 01, 2008 1:16 pm

Let's say you log in to your brokerage account and see $100,000 in there. Then you log in a few months later and there's only $65,000 in there. How would you feel about that? Could you stay the course and leave the money invested?

Your bond allocation should reflect your need and your ability to take risk. You are young which should increase your ability to take risk, since your time horizon is long. However if you make tons of money then you might not need to take a lot of risk to meet your goals.

Personally I am slightly more conservative than 110 minus age in stocks - I go for the old "age in bonds" method. This reflects my personal need and ability to take risk.
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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby Taylor Larimore » Tue Jul 01, 2008 1:47 pm

caklim00 wrote:I'm interested in hearing what others would do if they were (are) in their late 20s from an asset allocation standpoint between Equity and Bonds.

100/0? (Larry Swedroe upper limit)
90/10?
80/20? (Upper Limit from William Bernstein's Four Pillars book)

This is a question that I am struggeling with as I know I'm about 30 years till retirement, and am moving from an active strategy (how I got introduced in my early 20s to the investing world) to a long term passive strategy.

Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

Thanks for the help.


Hi C:

Our stock/bond allocation is our most important portfolio decision and one of the most difficult (it's not just "age"). Only you can make that decision and it depends on:

Your goals
Your time-frame
Your risk-tolerance
Your personal financial situation.

To help make this decision, Vanguard has an excellent web-page, "How to Create Your Investment Plan." Use this link:

https://personal.vanguard.com/us/planningeducation/general/PEdGPCreateHwToCreatePlnContent.jsp

Best wishes.
Taylor
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Postby Easy Rhino » Tue Jul 01, 2008 2:04 pm

I tend to recommend at least 10%, so at least there's the psychological benefit in a bear market of having SOME part of your portfolio that's still making money. Although with 10%, the benefit is mainly psychological, not financial.
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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby caklim00 » Tue Jul 01, 2008 2:05 pm

[
Hi C:

Our stock/bond allocation is our most important portfolio decision and one of the most difficult (it's not just "age"). Only you can make that decision and it depends on:

Your goals
Your time-frame
Your risk-tolerance
Your personal financial situation.

To help make this decision, Vanguard has an excellent web-page, "How to Create Your Investment Plan." Use this link:

https://personal.vanguard.com/us/planningeducation/general/PEdGPCreateHwToCreatePlnContent.jsp

Best wishes.
Taylor[/quote]

Thanks for the link. I took the survey and it said I should be 100% equity/ 0% bonds. Guess I have some more thinking to do...
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Bond allocation?

Postby Taylor Larimore » Tue Jul 01, 2008 2:17 pm

I took the survey and it said I should be 100% equity/ 0% bonds. Guess I have some more thinking to do...


I have found that most investors overweight their risk tolerance. Personally, I think 10%-20% is a minimum bond allocation (if for no other reason than to learn about bonds).

Regarding "risk tolerance," I like Adrian's forumula:

"Maximum tolerable Loss X 2 = maximum equity allocation"

In other words, figure that during the next big bear market your portfolio may decline about half its stock allocation.

Best wishes.
Taylor
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Re: Bond allocation?

Postby caklim00 » Tue Jul 01, 2008 2:28 pm

Taylor Larimore wrote:
I took the survey and it said I should be 100% equity/ 0% bonds. Guess I have some more thinking to do...


I have found that most investors overweight their risk tolerance. Personally, I think 10%-20% is a minimum bond allocation (if for no other reason than to learn about bonds).

Regarding "risk tolerance," I like Adrian's forumula:

"Maximum tolerable Loss X 2 = maximum equity allocation"

In other words, figure that during the next big bear market your portfolio may decline about half its stock allocation.

Best wishes.
Taylor


Thanks Taylor. If I heed this advice then that will put me around the 80/20 mark (as I probably was slightly overestimating my "risk tolerance")

I'm well aware the the best time to buy is at the point of "maximum pessimism" but I guess since I'm still a young investor I've never truely experienced the point of "maximum pessimism" yet.

Net: I'll probably target an 80/20 Allocation for the next 10 years, so I don't completely screw things up (IE. panic) if we have a prolonged bear market for years...
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Postby tat2ng » Tue Jul 01, 2008 2:32 pm

As Taylor mentioned, it is YOUR decision, but if you're just looking for examples....

My wife and I are both 28 years old. I'm in the process of fine-tuning all of my retirement accounts to work in unison, but my goal is 85/15 stock/bonds, but I would probably be willing to go up to 90/10. As you said, you have 30+ years to go.

We are all in index funds, except my wife has some money in Vanguard Explorer Admiral through her 401k.

Thad
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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby dumbmoney » Tue Jul 01, 2008 2:43 pm

caklim00 wrote:Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)


Ideally you would like to spread the investment risk evenly across time. That isn't possible, but the closest thing is to take as much risk as possible in the early years, and reduce risk later. The "life cycle" funds try to do this by gradually adding bonds. However, this strategy assumes that you will keep saving no matter what the market does (when in reality you might lose your job in a recession, at the same time the market tanks).
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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby caklim00 » Tue Jul 01, 2008 2:46 pm

dumbmoney wrote:
caklim00 wrote:Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)


Ideally you would like to spread the investment risk evenly across time. That isn't possible, but the closest thing is to take as much risk as possible in the early years, and reduce risk later. The "life cycle" funds try to do this by gradually adding bonds. However, this strategy assumes that you will keep saving no matter what the market does (when in reality you might lose your job in a recession, at the same time the market tanks).


Most lifecycle funds seem to have a 90/10 allocation for long term investors. Maybe this is the best route to go...
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Asset Allocation for 28 year old (Equity/Bond Split)

Postby YDNAL » Tue Jul 01, 2008 3:04 pm

100/0? (Larry Swedroe upper limit)
90/10?
80/20? (Upper Limit from William Bernstein's Four Pillars book)
caklim00,

This decision can't based on someone else's opinion, or a formula/guideline - it should be based on your need and ability (I left out willingness on purpose) to take risk. Believe me, the market will test your ability.

Be careful, at 28 (you were 20 in 2000), you haven't been tested to handle a 45% drop in your nest egg.

Regards,
Landy
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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby CyberBob » Tue Jul 01, 2008 3:05 pm

caklim00 wrote:100/0? (Larry Swedroe upper limit)

I'm with Larry, but his 100/0 recommendation was undoubtedly for the long-term portion of your portfolio only.
For you overall portfolio, check out his Liquidity Test section on page 173 of his book The Only Guide to a Winning Investment Strategy You'll Ever Need where he suggests that any money needed in the next 5 years should be out of stocks. When you get older, you could make it any money you need in the next 10 years should be out of stocks.

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Re: Asset Allocation for 28 year old (Equity/Bond Split)

Postby caklim00 » Tue Jul 01, 2008 3:20 pm

CyberBob wrote:
caklim00 wrote:100/0? (Larry Swedroe upper limit)

I'm with Larry, but his 100/0 recommendation was undoubtedly for the long-term portion of your portfolio only.
For you overall portfolio, check out his Liquidity Test section on page 173 of his book The Only Guide to a Winning Investment Strategy You'll Ever Need where he suggests that any money needed in the next 5 years should be out of stocks. When you get older, you could make it any money you need in the next 10 years should be out of stocks.

Bob

I have no (expected) need for money within the next 10 years. I have (I think) a stable job and my wife will be begining a new position from after college in August. I already own a house (20% down), and don't plan on moving in the next 5 years. So, my liquidity needs will be very low (unless the unexpected happens --> and this shouldn't with insurance and DB protection)...

Yes, Lary's book that you referenced is where I pulled the original 100/0 Asset Allocation from.

From a liquidity standpoint I probably should be closer to 100/0, but if you believe Bernstein that the future returns between stocks and bonds will be similar then I probably should be closer to 80/20.
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Postby waitforit » Tue Jul 01, 2008 3:37 pm

I am also 28 - this topic hits close to home for me.

I tend to recommend at least 10%, so at least there's the psychological benefit in a bear market of having SOME part of your portfolio that's still making money. Although with 10%, the benefit is mainly psychological, not financial.


I'm not so sure about that. Plenty of backtested data shows a tangible risk reduction without giving up much (if any) return. For that reason, I have a 80/20 allocation.

My portfolio, which I arrived at after much hand-wringing:
80/20 equities/bonds
66/33 US / foreign split (will slowly increase to 60/40 over time)

25% TSM index
15% SV (small cap value)
10% REIT
16% Int. Developed (includes emerging markets)
8% Int. small cap value
5% commodities
20% bonds (10% each TIPS and Intermediate treasury index)

Breaking it down - there is a good mix of low-correlated assets here. Both US and Int. are tilted to small and value, I hold a fairly standard REIT allocation, and I stick only to the safest of bonds as a portfolio anchor. I think this was the simplest way to acheive it as I hold relatively few funds.

Future asset classes may include:
Large cap value
Frontier markets
Overweight emerging markets (currently market weighting)

So thats all good, but how did I arrive at this mix?

I have a very stable job with decent income. Therefore, given that tilting to small and value has extra risk I felt it was appropriate for me to seek those premia. In spite of the stable job, I still hold 20% bonds. I'm not convinced that stocks will hold a large advantage over bonds in the returns department going forward. I've seen the data showing 80/20 compared to 100% equities and the 80/20 is far more compelling to me.

I am fortunate to have no-cost trading access to ETFs in my brokerage and Roth accounts - otherwise I would surely have a more typical asset allocation without commodies, without int. small value, etc.
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Postby renditt » Tue Jul 01, 2008 3:52 pm

I am 36 and until last fall, I was almost 100% in Equities (and most of it in single stocks). The market made me nervous and I changed fairly quickly

a) to almost a 50/50 allocation of stocks and bonds
b) from single stocks to index funds / ETFs

...and both of which made me sleep much better during the last 6 months.

I guess the point I am trying to make is that your capability to accept risk can change fairly quickly, at least it has for me. Also, in this market I don't see you giving up a lot of extra returns by moving a bit more money into bonds, however it might make you feel/sleep much better by reducing volatility. In your situation I would probably go with 30/70.

good luck
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Postby caklim00 » Tue Jul 01, 2008 4:26 pm

waitforit wrote:I am also 28 - this topic hits close to home for me.

25% TSM index
15% SV (small cap value)
10% REIT
16% Int. Developed (includes emerging markets)
8% Int. small cap value
5% commodities
20% bonds (10% each TIPS and Intermediate treasury index)


Why TIPS versus Short Term? I was thinking 50% Intermediate, 50% Short Term for my bond selection.
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Postby waitforit » Tue Jul 01, 2008 7:10 pm

Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.
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Postby caklim00 » Tue Jul 01, 2008 9:09 pm

waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.


Interesting, I'll have to take a look at Larry's book tonight. In the end I'm just hoping to smooth returns a bit without sacrificing too much long term returns with my bond allocation.
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Postby Curtis Lowe » Tue Jul 01, 2008 9:37 pm

caklim00 wrote:
waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.


Interesting, I'll have to take a look at Larry's book tonight. In the end I'm just hoping to smooth returns a bit without sacrificing too much long term returns with my bond allocation.


For what it's worth, I'm 35 and have a high income with a stable job..I go all equities and REITs now, until all my debt (student loans and mortgage) are paid off or substantially paid off...i view the debt payoff as the fixed income portion of my portfolio...good luck
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Postby jh » Tue Jul 01, 2008 10:06 pm

...
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Postby arbogast777 » Wed Jul 02, 2008 12:30 am

I'm 30 and am at 80/20 (plan to adjust it by 10% every decade). My bonds are 1/2 Intermediate and 1/2 TIPS.

Don't look at bonds as a drag on your portfolio. Since 1997, the Total Stock Market Index has averaged 3.54% a year while the Intermediate Bond Index has averaged 5.99% a year.
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Postby LHerr » Wed Jul 02, 2008 7:31 am

"I'm interested in hearing what others would do if they were (are) in their late 20s from an asset allocation standpoint between Equity and Bonds."

I would go with 100% equities. But before making that move, I would spend $14 on Mark Hebner's book, "Index Funds: The 12-Step Program for Active Investors" or read it on line. Check out this link.

http://www.ifa.com/

On this site you will find a questionnaire you can take that will help you determine what risk you are willing to take as you plan your portfolio.

LHerr

http://www.lherr.org/blog/
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One Sided View..

Postby Trev H » Wed Jul 02, 2008 7:35 am

.
Bonds will reduce the risk of your portfolio, reduce volatility, and reduce bear market losses.

They will also reduce your longterm return.

I think Bernstein put it this way, don't expect safety without correspondingly low returns.

Most often Bonds are viewed as the safety net to reduce BEAR market losses (ie) the Formula that Adrian came up with that was stated by Taylor earlier (shown again below).

===

Regarding "risk tolerance," I like Adrian's forumula:

"Maximum tolerable Loss X 2 = maximum equity allocation"

===

The goal of that is basically to make sure that you can stick to your AA in the worst of times.

But what about the BEST of times ?

What is your Maximum tollerable portfolio performance drag ?

If you allocate too much to bonds, and the market goes into a RAGING BULL string of years, how would you react to the drag that bonds put on your portfolio performance ?

Could you stand it ? or would you bail out and change to a more agressive mix near the end of the BULL ?

This is just thinking outside the box a bit, but it does make just as much sense as the other side of the issue.

Most folks suggest you "test" your bond allocation thru a 1973-1974 type BEAR market.

It would be just as important to "test" your bond allocation thru a 1995-1999 type BULL market (IMO).

Ok... a backtest or two comming up ;-)

3 Portfolio's tested thru 1973-1974 and 1995-1999.

Total change in portfolio value listed from Year End 1972 to Year End 1974 and again from Year End 1994 thru Year End 1999.

P1 = 70% US Market, 30% Intl Market
P2 = 55% US Market, 25% Intl Market, 20% Total Bond
P3 = 40% US Market, 20% Intl Market, 40% Total Bond

Yearly Rebalancing

Year End 1972 thru Year End 1974

P1 = -39.00%
P2 = -30.11%
P3 = -20.67%

Year End 1994 thru Year End 1999

P1 = +176.20%
P2 = +142.98%
P3 = +112.94%

Holding 20% Bonds reduced your losses by 8.89% in the 1973-1974 BEAR
Holding 40% Bonds reduced your losses by 18.33% in the 1973-1974 BEAR

Holding 20% Bonds reduced your gains by 33.22% in the 1995-1999 BULL.
Holding 40% Bonds reduced your gains by 63.26% in the 1995-1999 BULL.

Just trying to show both sides of the Bond Allocation issue. One side is usually clearly stated (reducing losses), the other side is not.

Trev H
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Postby caklim00 » Wed Jul 02, 2008 2:18 pm

waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.


How do people on here get exposure to TIPS?
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Postby waitforit » Wed Jul 02, 2008 2:53 pm

Trev,

Good point on the 95-99 test. I guess it really depends where the market has been at in the few years leading up to retirement, doesn't it?

Big picture to me though is what CAGR can I expect during my years of investing. I'd rather have a CAGR of 14 with deviation of 30 than 10 with deviation of 8, but I cannot know that in advance - so the prudent thing is to include some bonds and shoot for a CAGR of 10 with deviation of 12.

CAGR = Compound Average Growth Rate

How do people on here get exposure to TIPS?


TIPS fund for me. VIPSX is a good one, there also some TIPS etfs out there.
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Postby Joypog » Wed Jul 02, 2008 7:35 pm

I've been reading Jack Brennan's "Straight Talk on Investing". His statement on page 60 made me much more comfortable with my 70/30 split (it seems that I'm just not as aggressive as other 28 year old compatriots).

The key thing to remember about balance (between stocks and bonds) is that at any point in time it will look like a dumb strategy.... With a balanced portfolio, it's true that you'll never be earning as much as you'd get if you managed to put all your money in the asset class that was destined to be the year's top performer.


I've been reading a bit, and IMHO I get the impression that the current climate is much more aggressive on the stock/bonds balance than in older pre-internet bubble books. I'm not totally sure why and its just my anecdotal experience but I have noticed that currently, (and definitely on this board), people are weighing very heavily on the stocks (and certainly international stocks).

Here's another interesting chart from Brennan's book (Page 71)
Mix -----> Number of years out of 76 with a loss (Betw 1926-2001)
50/50 17 years (22%)
60/40 19 years (25%) Exactly one out of four
80/20 21 years (27%)
100/0 22 years (29%) Almost three years out of ten
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