How do I decide on Asset Allocation for a 3-fund portfolio

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TomCat96
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How do I decide on Asset Allocation for a 3-fund portfolio

Post by TomCat96 » Wed Jan 27, 2016 6:03 pm

Hello everyone,

I am still pretty new to this site, and am still in the midst of learning all the ins and outs.
I have been reading about the 3 fund portfolio and trying to take advantage of its simplicity and efficacy.

But I am not sure how to decide on an asset allocation. I am in my early 30s and am very risk tolerant. I enjoy seeing the market go down because it usually means I can buy more. Retirement is more than 30 years away.

So far Vanguard's allocation selector recommended a 100% total stock market allocation for me. That leaves me head scratching a bit because I don't see how I can take advantage of a 3 fund portfolio strategy with rebalancing if my recommended allocation at this time is 100% stocks.

96% of my money is currently in treasures as I sit here trying to figure out how to allocate my assets before I decide to jump in.
Is the current strategy for someone in my position to simply load up on Vanguard Total Stock Market Index Fund (VTSMX) at this time?

Any advice is appreciated!

rkhusky
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by rkhusky » Wed Jan 27, 2016 6:06 pm

I would suggest at least 10% bonds, maybe 20%. Also between 30% and 40% in international.

RadAudit
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by RadAudit » Wed Jan 27, 2016 7:43 pm

You can try several approaches. We don't have much info on you so this is in generalities.

The usual warnings about need, ability and willingness to assume risk may provide some insight. I wouldn't take any more risk than I needed to take to meet my financial goals. So, how much money do you need to have and when do you need to have it to meet your goals? How much can you contribute toward those goals each year? I think there are retirement calculators that can answer those questions. Well, at least they can do the number crunching.

The next trick is to pick an asset allocation that will let your portfolio make the rate of return you you need to meet your goal.

Or you can just forget all that and put it in to a target date fund keyed to your target retirement date. They rebalance and they keep to a glidepath that gets more conservative as you age. And keep adding money.
Last edited by RadAudit on Wed Jan 27, 2016 8:08 pm, edited 1 time in total.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The Calvary isn't coming, kids. You are on your own.

asset_chaos
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by asset_chaos » Wed Jan 27, 2016 7:45 pm

You could invest through a target retirement fund. That's essentially, though not exactly, a 3-fund portfolio, but one that does the rebalancing for you---and it's even simpler than a 3-fund portfolio.

It that's not right for you, if you want to see the moving parts and experience how they react in different market conditions, that's fine too. Don't get hung up on what some risk quiz or robo-advisor says. 100% stocks is pretty risky, and there's no reason you have to bear that much risk, even if you have the emotional ability to. I think even the young should have some bonds because one day even the young will become old enough to want or need some bonds, so why not experience there behavior under various market conditions. 10 or 20% at the least, just to see how they work.

If you're not sure where your risk allocation should be, you could do worse than to start with one of the lifestrategy funds and mimic it's allocation with a 3-fund portfolio. See how you go with that during both exuberant and despondent market conditions, then adjust accordingly. You might even start with a little less risk than you think you can bear. It's easier to adjust risk up after a downturn, than to be surprised that the risk, when it's eating your hard earned money, really is more worrisome than you had thought.

Puzzling out one's risk tolerance is not easy. Best wishes for your journey of risk self-discovery.
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David Jay
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by David Jay » Wed Jan 27, 2016 10:11 pm

rkhusky wrote:I would suggest at least 10% bonds, maybe 20%.
Agree. There are two benefits to holding some bonds (even though you are not worried about stock market fluctuations): Improved risk/return (search for threads on "efficient frontier") and rebalancing.

Rebalancing means maintaining your asset allocation (let's say it's 80%/20%). This involves selling some of the bonds and adding to your stock portfolio after a drop in stock prices (stock percentage is less than 80%). In reverse, selling some stock and adding to your bond portfolio when stock prices have gone up (stocks percentage is more than 80%).

This is a carefully controlled way to "buy low, sell high". There is a new study out that suggests that the historic benefit for an 80% portfolio is as high as 2% in long term gains if you follow the 3% rule. As always, past performance != future performance.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Watty
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by Watty » Wed Jan 27, 2016 11:27 pm

asset_chaos wrote:You could invest through a target retirement fund. That's essentially, though not exactly, a 3-fund portfolio, but one that does the rebalancing for you---and it's even simpler than a 3-fund portfolio.
+1

If if you decide to use a three fund portfolio for some reason, like your funds are spread between several account types, then you could still look at the appropriate target retirement account to see what asset allocation it uses.

llamslag1221
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by llamslag1221 » Thu Jan 28, 2016 2:26 am

Is there a rule of thumb to decide the proportion among 3 funds? I'd like to learn.

RadAudit
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by RadAudit » Thu Jan 28, 2016 10:28 am

llamslag1221 wrote:Is there a rule of thumb to decide the proportion among 3 funds? I'd like to learn.
Welcome to the forum.

You might want to start your own thread with that question; but, the short answer is probably not.

There's an ongoing debate concerning the domestic / international stock split. Very passionate, very well reasoned.

And there is a debate about the stock / bond split. That revolves around the need, ability and willingness to take risk with a bias toward a higher bond allocation the closer you get to retirement.

Start here https://www.bogleheads.org/wiki/Three-fund_portfolio and here viewtopic.php?t=156591 Read the linked discussions / articles.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The Calvary isn't coming, kids. You are on your own.

Lafder
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by Lafder » Thu Jan 28, 2016 10:44 am

I rec no less than 20% bonds.

There is a general rec of age in bonds down to age - 20 in bonds if you want to be "aggressive" But as I said, I rec 20% even if you are 20 yo and want to be aggressive. Bonds buffer drops more than they drag down gains. They give you space to rebalance from in stock market crashes, which gives you something to do besides look at your lower balance and feel bad, you get to buy stocks on sale!

As far as % International, some say 0% is fine, Bogle himself does. But if your portfolio is as big as his, all cash is fine too! Vanguard used to rec 20-40% International. Last year they raised their recs to 30-50% International stocks and bonds. I am at 30% based on their old recs and have not made a change. I might. See below :)

There is no "right" answer or we would all do it ! More important than the AA #s you choose, is to try to stick to a plan and not change it every time the market changes or you read something else :)

As mentioned, the VG all in one funds are basically 3 fund portfolios, plus International bonds, that rebalance for you. The TD (Target date) funds add bonds with age so their AA shifts, the Life Strategy funds stick to a set AA over the years. Both rebalance to their stated AA for you when the market shifts.

lafder

EnthusiasticLearner
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by EnthusiasticLearner » Thu Jan 28, 2016 11:05 am

Lafder wrote:There is no "right" answer or we would all do it ! More important than the AA #s you choose, is to try to stick to a plan and not change it every time the market changes or you read something else :)
^ This!! We are some of the total crazies that had less than 0% bonds from 1996 to 2006 and less than 10% from 2006-2015. And we were okay with that. Never blinked. But, we are in a different stage of our lives now so we upped it to 15%. We're still considered the crazies by many, but that is okay because we are committed to our plan. This is not to say that you should keep doing something if that thing is a mistake (e.g., paying a high cost advisor), but if you are in low cost funds, then just stay the course until time passes or you have a major life event. I'm not sure where you will be housing this money, but I'd buy some Total Stock Market in your roth and/or your taxed accounts. Like RIGHT NOW.

jimkinny
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by jimkinny » Thu Jan 28, 2016 11:44 am

Maybe you are one of those people who need to take a lot of risk, are willing and have the ability to do.

Many people think they are in this group, until they lose, what to them is a lot of money, over 6-12 months.

the most rational way to approach this is need, ability and willingness to take risk. Go to the boglehead wiki and spend some time with the retirement calculators. These are just tools that can be used to start the process of learning how to achieve your goals. Play around with various inflation, saving and return scenarios to start getting a feel for what level of risk you need to take to achieve your goal.

There are quite a few people who think that equity and bond returns over the next 10 years or so will be lower than what many predicted 10-15 years ago and perhaps inflation also. There are so many unknowns that you can expect a lifetime of change re this stuff.

Rick Ferri, on his blog/website posted an article in which he recommended starting at a lower level of riskiness than what you think you can handle, then when your experience a sever downturn in economic and market conditions, learn from you reactions.

IMO, the worst thing you can do is start too aggressive, sell at a market downturn and take big losses.

Read the boglehead guide to retirement and also guide to investing for starters. Larry Swedroe had a book published several years ago that dealt mainly with this topic. It is well worth reading. He has had a lot of books published but in retrospect, i found this book most helpful in thinking about risk.

TomCat96
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Re: How do I decide on Asset Allocation for a 3-fund portfolio

Post by TomCat96 » Thu Jan 28, 2016 8:17 pm

thanks everyone. I greatly appreciate the advice. I'm in federal service which means the majority of my investing will be done within the TSP.

I've been looking into and giving more consideration to the lifestyle funds L2040, L2050 based on everyone's recommendations and observations.
I think the most valuable thing about posing this question was not so much getting a direct answer as it was being pointed to fruitful directions of learning and exploration.

I've taken very deeply to value investing philosophies since I was 24. I've read through the Intelligent Investor and worked through Security Analysis by Benjamin Graham. Philosophically that would place me as "Bogle-like" but not necessarily Boglehead. Intelligent Investor I believe recommended no greater than 80% stocks and 20% bonds.

I the next thing I plan on doing, based on jimkinny's suggestion is going around and playing with the mathematics of different bond allocations.

Analytically cracking down the philosophy and the power behind the 3 fund portfolio, I believe bonds effectively serve the function of cash+interest in any given portfolio. Bonds effectively are the safe "cash reserve" that allow you to buy into stocks (aka rebalance) when stocks are down, and by extension your target ratios become misaligned. It just so happens they also gain interest as well.

In terms of hedging risk, to the extent they are countercyclical, they reduce the standard deviation(or variance) of your overall portfolio.

Based on that thinking, I believe that the optimal proper answer to the bond allocation would depend on which other funds I choose.
Basically I would have to play around with a calculator and make some excel financial models to find my answer, which should depend on the risk of the other portfolios.

In light of my conclusions, I have also decided that strictly speaking at this time, my net worth is small enough that even if i were to go all in 100% in stocks, and even if I did experience a major crash, the dollar cost averaging on my subsequent purchases is enough to serve as the "function" of the bond allocation. My net worth is growing at a rate of 30% every six months. If i was 100% stocks today, 6 months later I could be at 70/30.. Basically I don't have much to lose yet.

I think that that probably gives me a mistaken resilience to drops in assets...knowing that I could lose nearly everything and be back where I am in about a year and a halfs time. Undoubtedly that will change in the future as the value of my portfolio rises, and the value of a bond allocation to weather drops in the market becomes more palpable.

I will probably analyze various lifestyle funds and gauge their asset allocation overtime. But I do have a feeling I will probably arrive somewhere between 60/40 and 80/20.

At any rate, I thank you all greatly for your input. It's been remarkably fulfilling to think about each of your answers and their implications.

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