Asset Allocation Driver

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mbizzle
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Asset Allocation Driver

Post by mbizzle » Mon Oct 07, 2019 10:14 pm

All - It seems to me that age and risk tolerance seem to be the biggest driver of asset allocation on this forum. How about total investable assets? Wouldn't your net worth be a significant driver of your risk tolerance? Let's say your investment plan says your AA will be 90/10 until 35 then 85/25 until 40, 80/30 until 45 and increasing the bond allocation by 5% every 5 years..

IE if you have 250k in assets and you are running a 90/10 at age 30 and then you have 750k of assets does it make sense to keep the initial AA listed above? My risk appetite in theory hasn't changed from when I created the IPS but given I saved a substantial amount more than I expected and am that much closer to winning the game shouldn't your AA shift? If not with 750k then 2m.

Clearly there is a number where your AA should shift, so given this doesn't it make sense to have a dynamic AA based on total wealth layered on top of age and risk tolerance.

Ferdinand2014
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Re: Asset Allocation Driver

Post by Ferdinand2014 » Mon Oct 07, 2019 10:54 pm

35 year old, living expenses 50,000/year at an AA of 90/10 with 500,000 will have 1 year of expenses in fixed income.

70 year old, living expenses 50,000/year at an AA of 90/10 with 5,000,000 will have 10 years of expenses in fixed income.

I do not have an AA, rather an X amount that allows me to sleep well at night based on at least 2-3 years of expenses and anticipated large purchases over the next 1-3 years in reserve as T-Bills at all times. What percent of my portfolio this may be is irrelevant.

The difficulty is seeing a 5,000,000 portfolio cut in half vs a 50,000 portfolio in 2008-2009 for example. If you can maintain employment, continue to add monthly (dampening the portfolio drop) and a large cash pile (knowing it will cover your expenses for at least 2-3 years) under the mattress to sleep on at night helps.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

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JoMoney
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Re: Asset Allocation Driver

Post by JoMoney » Tue Oct 08, 2019 12:37 am

I don't think it's just this forum. If you look at the models used broadly in the industry, risk tolerance and age are pretty widely used, and probably for good reason.
John Maynard Keynes wrote:Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.


I suppose there are social/religious factors that could influence the allocation too.
Islamic investing typically doesn't allow for investing in typical bonds.
Dave Ramsey advises against bonds, he drags his feelings about debt into it, but his primary justifications are performance related. https://youtu.be/iRtFDvGORQk ... I'm sure hearing Dave discuss bonds will trigger some :twisted: ...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

rkhusky
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Re: Asset Allocation Driver

Post by rkhusky » Tue Oct 08, 2019 7:14 am

mbizzle wrote:
Mon Oct 07, 2019 10:14 pm
All - It seems to me that age and risk tolerance seem to be the biggest driver of asset allocation on this forum. How about total investable assets? Wouldn't your net worth be a significant driver of your risk tolerance?
Years until retirement might be a better driver than age. And your net worth in comparison to expenses might be a good connection to years until retirement. However, it also depends on personality. Some, with more saved than they need, decide to increase risk, because they have a cushion for any losses. Others, in the same situation, decide that they have won the game and dial down their risk.

Dandy
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Re: Asset Allocation Driver

Post by Dandy » Tue Oct 08, 2019 10:25 am

I think the size of your portfolio can be a factor in determining your allocation depending on your goal. Let's say you set a goal of having 2 million to retire by age 60 and at age 45 you have 1.5 million. If you current allocation is 80/20 do you need that level of risk to reach your goal? Probably not. 2% average growth might get you there in the 15 years to age 60. That doesn't include any savings or company matches. The original NEED might not be there.

So do you have a new goal or new allocation? Maybe the new goal might be to consider retiring earlier than 60 or saving a bit less now to enjoy these earning years more. I guess if you are projected to be way ahead of your goal it might be time to rethink life and your allocation. Money is a means to an end not an end in itself -- you can't take it with you - Darn.

dbr
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Re: Asset Allocation Driver

Post by dbr » Tue Oct 08, 2019 10:41 am

The driver for asset allocation is the investor who must exercise personal judgement and preference in reaching an asset allocation plan.

The process of examining need, ability, and willingness to take risk is a good framework for attacking that problem but is not a formula or a simple and easy assessment to make. All of the factors of age, portfolio size, aspects of risk tolerance, and so on are encompassed in these factors by considering why age, portfolio, and so on should affect asset allocation and in what way for each investor.

Other approaches are formulas that may or may not be a thoughtful and appropriate plan for anyone in particular.

Possibly the saving grace of using formulas is that most formulas will end up with some kind of middle course for asset allocation and that will also be where a more thoughtful assessment might well end up.

Then again one could just say invest 60/40 in total market indices of stocks and bonds and go away, for all the difference it will make over a lifetime.

The mistakes that one can make in asset allocation might include the following:

1. To be too conservative when starting out and lose long time compounding of better returns.

2. To be too conservative during retirement and not have enough return to sustain chosen spending.

3. The granddaddy of all mistakes, which is to repeatedly panic and sell out when risky allocations crash followed by buying in again after markets have recovered.

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Phineas J. Whoopee
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Re: Asset Allocation Driver

Post by Phineas J. Whoopee » Tue Oct 08, 2019 2:35 pm

This is what I did and why, and a couple of years later I answered some questions about it.

For the record I think an age-based allocation approach will be far more practical for most investors to choose and stick with. OP is exploring other paths.

PJW

chem6022
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Re: Asset Allocation Driver

Post by chem6022 » Tue Oct 08, 2019 11:08 pm

In hard to give general advice here, because there are two very different risk profiles as peoples porfolio's get very large. One set does what you describe and gets more conservative once they have won the game. But another set of people gets more aggressive as their wealth grows, with the logic being something like 10% of my portfolio is 50 years of expenses in bonds, so why do I need more bonds?

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Eagle33
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Re: Asset Allocation Driver

Post by Eagle33 » Wed Oct 09, 2019 12:58 am

AA should be driven by your risk capacity - number of years before needing the money. Then adjusted slightly for your risk tolerance.
Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.

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FiveK
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Re: Asset Allocation Driver

Post by FiveK » Wed Oct 09, 2019 2:24 am

mbizzle wrote:
Mon Oct 07, 2019 10:14 pm
How about total investable assets? Wouldn't your net worth be a significant driver of your risk tolerance?
It could be a driver for one's asset allocation, but risk tolerance may be an input rather than a result. There are two opposing conclusions one could draw from the premise "you have more than enough assets":
a) no further need to take risk - invest conservatively
b) no downside to taking risk - invest aggressively

One's innate risk tolerance may sway one to opt for "a" vs. "b" even though both are defensible.

dbr
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Re: Asset Allocation Driver

Post by dbr » Wed Oct 09, 2019 8:42 am

mbizzle wrote:
Mon Oct 07, 2019 10:14 pm
Wouldn't your net worth be a significant driver of your risk tolerance? Let's say your investment plan says your AA will be 90/10 until 35 then 85/25 until 40, 80/30 until 45 and increasing the bond allocation by 5% every 5 years..

IE if you have 250k in assets and you are running a 90/10 at age 30 and then you have 750k of assets does it make sense to keep the initial AA listed above? My risk appetite in theory hasn't changed from when I created the IPS but given I saved a substantial amount more than I expected and am that much closer to winning the game shouldn't your AA shift? If not with 750k then 2m.

In this case a person with a lot more money than expected should maintain at least 90/10 in order to aggressively grow their wealth now that they have enough not to worry about market declines. The game changes when you have far more than you need.

Dandy
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Re: Asset Allocation Driver

Post by Dandy » Wed Oct 09, 2019 9:02 am

The game changes when you have far more than you need
.

It can. The NEED to take risk is less even though the risk tolerance might remain the same. If the goal is the same e.g. a certain asset level at a certain age - that seems to tilt in favor to a lower risk unless there is a new goal e.g. retire earlier? buy a vacation home at the lake? You certainly can take high risk but you should really try to understand why?

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House Blend
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Re: Asset Allocation Driver

Post by House Blend » Wed Oct 09, 2019 9:38 am

FiveK wrote:
Wed Oct 09, 2019 2:24 am
mbizzle wrote:
Mon Oct 07, 2019 10:14 pm
How about total investable assets? Wouldn't your net worth be a significant driver of your risk tolerance?
It could be a driver for one's asset allocation, but risk tolerance may be an input rather than a result. There are two opposing conclusions one could draw from the premise "you have more than enough assets":
a) no further need to take risk - invest conservatively
b) no downside to taking risk - invest aggressively

One's innate risk tolerance may sway one to opt for "a" vs. "b" even though both are defensible.
I'm in the My Cup Runneth Over Club, and have opted for

c) no need to change AA.

If it ain't broke don't fix it.

In any case, removing "need" from the need/willingness/ability trinity makes the decision easier.

pkcrafter
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Re: Asset Allocation Driver

Post by pkcrafter » Wed Oct 09, 2019 11:41 am

mbizzle wrote:
Mon Oct 07, 2019 10:14 pm
All - It seems to me that age and risk tolerance seem to be the biggest driver of asset allocation on this forum. How about total investable assets? Wouldn't your net worth be a significant driver of your risk tolerance? Let's say your investment plan says your AA will be 90/10 until 35 then 85/25 until 40, 80/30 until 45 and increasing the bond allocation by 5% every 5 years..

IE if you have 250k in assets and you are running a 90/10 at age 30 and then you have 750k of assets does it make sense to keep the initial AA listed above? My risk appetite in theory hasn't changed from when I created the IPS but given I saved a substantial amount more than I expected and am that much closer to winning the game shouldn't your AA shift? If not with 750k then 2m.

Clearly there is a number where your AA should shift, so given this doesn't it make sense to have a dynamic AA based on total wealth layered on top of age and risk tolerance.
Asset allocation is based on 3 determinations - need, ability, and willingness.

Need would consider total assets and desired long term portfolio value.
Ability would consider income and expenditures and savings rate.
willingness considers comfort zone risk exposure.

Often investors will have need with limited financial ability, or have lots of ability with little need. Personal risk tolerance overlays the final decision and the selected allocation almost always involves a compromise among the three drivers.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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