Over four years ago I did a post about my asset allocation, along with a couple of follow-up posts- one answering questions about the asset allocation and one demonstrating how I was implementing it at that time. The asset allocation only changed slightly (and was documented on the blog.) But the manner in which it is implemented has certainly changed. It was requested that I give an update, so here's that update.
First, let's review my asset allocation. I'm literally cutting and pasting this from my 2012 post.
75% Stock
50% US Stock
Total US Stock Market 17.5%
Extended Market 10%
Microcaps 5%
Large Value 5%
Small Value 5%
REITs 7.5%
25% International Stock
Developed Markets 15%
Small International 5%
Emerging Markets 5%
25% Bonds
Nominal Bonds (G Fund) 12.5%
TIPS 12.5%
While I've considered a lot of changes in that time period, the only one I've actually made is to put 5% of the portfolio into P2P Loans. That 5% came from the G fund and the TIPS allocation.
The Reasoning Behind the Asset Classes
Why do I have all of these asset classes? It's important to remember the reason you have your investments, so this is a good chance for me to do just that.
- Total US Stock Market- Capture market returns at low cost.
- Total International Stock Market/Developed markets- Diversify into other markets with other currencies, essentially owning all the publicly traded stocks in the world between the two funds.
- Small Value- Capture small and value tilt, boosting returns compared to a total market portfolio
- Large Value- Capture value premium, boosting returns compared to a total market portfolio
- Microcaps- Capture small premium, boosting returns compared to a total market portfolio. Attempt to capture CRSP 10 returns, the highest historical returns of any segment of the stock market.
- Extended Market (Mid-caps)- Mid-caps have been the “sweet spot” for historical returns, at least for the last 20 years. Also adds on more small premium. The theory is that mid-caps avoid issues present in the large-caps (bubbles) and in the small caps (post-IPO cratering.)
- REITs- Different type of company structure with relatively low correlation with the overall market, diversification into real estate.
- Small International- Capture small premium with international stocks.
- Emerging Markets- Diversify into markets not captured by US and Developed Markets Fund, overweight to capture potential premium.
- TIPS- Protect against inflation and deflation, moderate stock market volatility.
- G Fund- Protect against inflation, moderate market volatility, diversify and moderate TIPS.
- P2PL- Diversify and boost returns.
Now, before we move on, let me emphasize this is my retirement portfolio. I have other portfolios as well. Each goal I have gets its own portfolio.
Taking a break on Day 5 of a canyoneering trip
Emergency Fund/Short Term Savings Portfolio
100% Ally Bank High Yield Savings Account
College Portfolios (in the Utah 529s)
The ones for my kids are:
- 50% Total International Stock Market
- 25% Vanguard Small Value Index Fund
- 25% DFA Small Value Fund
The ones for my nieces and nephew (much smaller) are:
- 50% Total Stock Market Index Fund
- 50% Total International Stock Market Index Fund
Childrens 20s Funds (in Vanguard UGMAs)
- 50% Total Stock Market Index Fund
- 50% Total International Stock Market Index Fund
Childrens Roth IRAs (Vanguard)
- 100% Target Retirement 2060 Fund
Health Care Fund (in an HSA Bank/TD Ameritrade HSA)
- 100% Vanguard Total Stock Market ETF
Mortgage Pay-off Fund
This is 100% stock, a bit of a play money account, mostly tilted to high-volatility and high expected return asset classes with the goal to tax loss harvest losers and donate winners to charity. There is no written investment plan for this account. As I write this post, it looks like this:
- 23% Vanguard Precious Metals and Mining Fund
- 7% Vanguard Energy ETF
- 21% Vanguard Emerging Markets ETF
- 7% Vanguard Health Care ETF
- 15% Vanguard 500 Index ETF
- 26% Vanguard Total International Stock Index ETF
Real Estate
I also have some real estate I've been dabbling into and may eventually fold into my retirement allocation. I'm really not sure what I'll end up doing with this. It's a very small chunk of our net worth and discussed in more detail here.
- Equity 79%
- Preferred Debt 15%
- Debt 6%
The Retirement Accounts
So, now that we've been through all that, none of those accounts are particularly large in relation to our net worth which is primarily in our retirement accounts, our house, and the value of our business. Our retirement accounts look like this:
- His Roth IRA (mostly at Vanguard with some at Lending Club) 19%
- Her Roth IRA (Vanguard) 11%
- His TSP 18%
- His Partnership 401(k) (Schwab) 32%
- His Partnership Defined Benefit/Cash Balance Plan (mostly ignored for AA purposes, but around 70/30 last I checked.)
- His WCI 401(k) 15%
- Her WCI 401(k) 5%
Here is how things are currently set out.
His Roth IRA 19%
- Lending Club P2P Notes 4%
- Vanguard REIT Index Fund 8%
- Bridgeway Ultra Small Company Market Fund 5%
- Vanguard Total International Stock Index Fund 2%
Her Roth IRA 11%
- Value Index Fund 5%
- Small Value Index Fund 5%
- Total International Stock Index Fund 1%
His TSP 18%
- G Fund 10%
- S Fund 8%
His Partnership 401(k) 32%
- Schwab TIPS ETF 8%
- Vanguard Emerging Market ETF 5%
- Vanguard Small International ETF 5%
- Vanguard Total Stock Market ETF 14%
His WCI 401(k) 15%
- Inflation Protected Securities Fund 2%
- Extended Market Index Fund 1%
- Total International Stock Index Fund 12%
Her WCI 401(k) 5%
- Total Stock Market Index Fund 4%
- Extended Market Index Fund 1%
There is a total of 7 accounts (His Roth IRA is in two places), 12 asset classes, and, ignoring admiral/investor share class differences, 15 different investments. Now let's critique it a bit.
The Good
- Low-Cost – The average expense ratio of the entire portfolio is 14 basis points. Could it be lower? Sure, but when you're down below 20 basis points, there isn't a lot of benefit to trying to lower that, especially when there are NO advisory fees on top of it. I mean, I'm stuck with higher investor share class ER in the individual 401(k)s, the Lending Club fee is 1%, and the Bridgeway fund is 0.78%. Maybe if I dropped those two asset classes and moved the individual 401(k)s somewhere else I could get down to 10 basis points. No biggie.
- Easy to Rebalance – For such a complex portfolio, the rebalancing is really easy. You'll notice the presence of the Total International Fund in four of the six accounts and the S Fund/extended market index funds in 3 of the accounts. That's where the magic happens. When I need to add to something else in the account, it comes from those funds and more is added to those funds in another account. The only painful one is the P2PLs which require an IRA transfer to rebalance and make contributions. I actually do that two or three times a year.
- Takes Advantage of The Good Things In Each Account – The only place you can invest in the G Fund is in the TSP, so that's where I put that. At Schwab, there are no commissions for Schwab ETFs, and I see little difference between the Schwab and the Vanguard TIPS ETFs, so I just used the Schwab one. The Vanguard ETFs there are available for a low commission. Everything else is at Vanguard where the only dilemma is which funds to choose to get the Investor class ERs in the individual 401(k)s and which ones to put in the IRAs.
- Higher expected return assets in the Roth IRAs – This is a very minor point, but I actually increase the risk of my portfolio slightly (thus hopefully boosting returns) by keeping higher returning assets in the Roth IRA as opposed to the 401(k)s. Since I don't adjust my AA for tax considerations due to hassle (tax adjusting them is probably the academically correct thing to do), that's how it works out.
The Bad
- Complexity – Nobody can argue in good faith that anyone needs 12 asset classes. You can see how complex it can get trying to move around twelve asset classes in seven different accounts. I think the minimum is three asset classes, and I think there is pretty good bang for your buck going from three to seven. There may even be some advantage in going from seven to ten. But over 10? Who are we trying to kid? At this point we're just playing with our money. What are the likely candidates for being dropped at some point in the future? In no particularly order, Large Value, Extended Market (mostly mid-caps), Micro-caps, P2P Loans, REITs. Dropping all of those would get us down to seven.
- Overloaded on Emerging Markets – The original plan called for 15% Developed Markets. That was back when I was using the TSP I Fund, which does not include Emerging Markets. However, over the years I gradually moved I Fund money into the G and S Funds because I wasn't adding new money to the TSP. Meanwhile, I was substituting TISM instead of Vanguard Developed Markets fund for the I fund because I think it is a better fund. But I was still holding a separate emerging markets fund. By the time I realized how overloaded I was in EM, it had already tanked and I didn't want to sell low, so I'm just riding it out. I'll probably fix it at some point.
- Bond ETFs Not Great – There are some issues with bond funds, but even more issues with bond ETFs. They may not apply much to an ETF that is all treasuries, but I'd eventually like to get out of the Bond ETF game. So I'm gradually adding money to the TIPs Funds in the individual 401(k)s and not adding more money to the Schwab TIPS ETF. To be honest, those individual 401(k)s have made rebalancing much easier than it used to be! I may eventually just own individual TIPS instead of a fund at all, but so far it hasn't been worth the extra hassle to me.
- Ignoring the HSA – Since I'm investing my HSA for the long haul, I probably ought to include it in the retirement asset allocation. The same argument could probably be made for the real estate stuff in taxable and maybe even the mortgage pay-off fund.
Comparing to 2012
Well, let's compare to what was going on back in 2012. In 2012, we had six accounts, eleven asset classes, and thirteen funds. So we're a little more complex due to the additional asset class and additional accounts, but not terribly worse. Back in 2012, I had seven asset classes in my Roth and now I'm down to four. I have more asset classes in my partnership 401(k) as it has grown, and fewer in the TSP which has not had any additional contributions (actually I did transfer my DBP in there when it was closed.) And of course we have since started individual 401(k)s. The retirement portfolio is about four times the size it was at the beginning of 2012. This is due primarily to additional contributions, but also due to decent returns. Our returns have been:
- 2012 13.9%
- 2013 19.7%
- 2014 6.3%
- 2015 -0.3%
Contributions for those years include (counts money added to the portfolio during that calendar year, not contributions assigned to that tax year):
- 2012 $60,500
- 2013 $87,923
- 2014 $117,021
- 2015 $164,952
Conclusions
Our trek toward financial independence continues. Our income is higher, our retirement nest egg nearly quadrupled in the last four years, we have started a significant taxable account, and we have made lots of progress toward our other goals.
What do you think? Is that portfolio insane or what? Do you have a written investing plan? How are you invested these days? Has it changed much in the last 5 or 10 years? What is your asset allocation? Are you making progress toward your goals? Comment below!
While your allocation seems complex at first glance, it really isn’t all that complex overall. Much of it is just understanding why you are putting your money into different places outside of the “basic” stocks and bonds. Overall, as long as you understand what each of your assets is doing for you than you’re golden.
I think the major deterrent for people just starting out is not knowing what all these acronyms and asset classes mean, which is why I try to KISS (Keep It SImple Stupid). I’m basically in the TSP variation of the Three Fund Portfolio from Tayor Larimore and I don’t see that changing for the foreseeable future. Since TSP doesn’t have TIPs or REITs options, I can’t use them, although I probably would like to. Overall, for me, having less options is probably is “safer” for me, to protect myself from… myself.
I also try to keep it simple. I have an overall 70% stock, 30% bond allocation using a three fund portfolio with Vanguard. I have the exact same 70% stock, 30% bond allocation with the exact same funds in each 401K, 457, IRA and taxable container (taxable uses Munis instead of Total Bond). I even have the same asset allocation and same funds in my HSA. It’s easy for me to just look at each account and know when to rebalance, no spreadsheet for me! (although I do keep an eye on the overall picture withe some financial software).
Kids Roth Ira should be 100% TOTAL S TOCK MKT INDEX, no doubt
not a retirement fund as the assets might never be touched and there is a growth period of 50 plus years!!!!
Lots of diversification as stated is the gold standard but I think it DID NOT work in the last crash as everything plummeted
Swedroe’s book has many different portfolios based on your risk tolerance
THE BIGGEST PROBLEM is what to do near retirement where you will have to live off that income. HOW RISKY will you be.
Best to OVERSAVE and have a bundle you can keep in equities yet still receive income from the remainder to live off of
You will become more conservative no matter what others might preach to you about having 30 plus yrs as a retiree.
If you could guarantee me great health, the scenario changes
High quality bonds, especially treasuries, didn’t plummet in 2008.
Can you briefly explain a kids roth? I have a kiddo coming 2017.
If your kid has earned income, you can open a Roth IRA and contribute an amount equal to the earned income up to $5,500 per year.
Reluctant to have any portfolio 50% int’l-Bogle says 20% max of your stock allocation
I agree
You’ve got quite a few funds in a bunch of places, and that’s not unusual, particularly for a physician who has been in both governmental and private practice, etc…
What is unusual is the fact that you know exactly where these dollars are, what they’re invested in, and why. A few years ago, I had a complex portfolio with much higher fees, and no particular rationale. I was diversified, but I couldn’t have told you the ratios in one account, let alone across accounts.
I’ve fixed all that now. A little education and a spreadsheet can do wonders for you.
Best,
-PoF
Don’t think your approach is “insane.” But only because you asked, two thoughts pop into my head.
First, your approach might be tricky to easily scale. E.g., just to play the “what if” game, say you liquidate the blog, get a big windfall, and then need to deploy $20M… is your approach still going to work in practice? My guess is, it’d be tricky. I would also guess you’d be tempted to add classes.
Second, if something happens to you, will your spouse be able to comfortably handle things? Like rebalancing, for example. FYI, I have the exact same “issue” in my retirement savings… And I met my wife in MBA school and she has a degree in finance and worked in banking… but I don’t think she’d be all that comfortable continuing the asset allocation I’m using. (Swensen’s 30% to US stocks, 15% each to REITs, developed Intl markets, TIPS, and intermediate treasuries, and then the last 10% to emerging Intl markets.)
Tips are yielding now a NEGATIVE #
I don’t think anyone is buying TIPS for their yield.
People buy them because of how they’ll probably impact our portfolios in a bad inflation scenario.
Love seeing articles like this. I don’t have the capital or sophistication to employ an asset allocation like this but it’s always enlightening to see/hear someone who is successful doing so.
Like other posters above, I use the 3 fund portfolio and it has worked well for me thus far. Don’t plan on deviating any time soon.
I think your portfolio is complex but reasonable because you understand the allocation.
One correction:
“TIPS- Protect against inflation and deflation, moderate stock market volatility.”
I think you meant that the nominal bonds protect against deflation; TIPS can have negative yields in deflationary period.
TIPS have a deflation protection feature as well. It doesn’t work as well as the inflation protection feature, but it is certainly there. It isn’t about the yields so much either. Nominal bonds can have both negative real and nominal yields too.
You’re right. My point was just that I consider nominal bonds to be deflation protection and TIPS to be inflation protection.
What I’m saying is you should expand your understanding of the value of TIPS in a portfolio. Yes, nominal is probably a little better in a deflationary scenario, but a TIPS is still a bond plus it never goes below par in value.
At first glance it seems pretty complicated, but as I think about my own allocation planning, it is similar. One thing that might be worth finding out is if your wife could just pick right up with it and keep going if you were suddenly out of the picture. I try to keep my plan written down, but the actual mechanics is nuanced (or I’m just so used to it) that it would be difficult to sustain function without a hiccup. Of course, as I type this, I understand that everything would be a whole lot different and the functioning of my asset allocation plan would likely be nowhere near the top of the Concerns List.
You’re right of course. But there are a few things that make me not worry about it much.
# 1 She’s smart and “gets” investing. So she probably could pick put this asset allocation and run with it. She probably wouldn’t, but she could.
# 2 She could totally ignore all of this for 2 or 3 years after I died and it would all go on just fine.
# 3 Almost all of it is very easily liquidated and invested in anything else. It’s mostly at Vanguard or in Vanguard funds. This could all be dramatically simplified if desired in one afternoon. Just move everything in a Vanguard account into Life Strategy Income, move the TSP into an L fund, and rollover the 401(k) to Vanguard. The only tricky part is dumping the P2PL. I’ve given that a lot of thought and that’s one reason I may eventually drop that asset class. Hard to argue with the returns and diversification so far though.
I wonder how this relatively complex AA compares to the standard three fund portfolio? Backtesting would be sort of messy here…
Nahhhh…there’s someone already doing it just fine.
https://www.bogleheads.org/forum/viewtopic.php?t=198720
Think of mine as the slice and dice portfolio (I usually do just slightly better). Since 99 it’s up 1.6% a year compared to the three fund. Much less of a difference since 06, but still on top.
Hi Jim,
Presumably you’re looking for feedback. If not, feel free to completely ignore what I’m about to say:
The Good
1: Low-cost, relatively broad diversification not just across geographical regions but across asset classes as well (small/large and value/growth).
2: The fact that you’ve had the allocation for many years indicates an ability to stay the course, which will save you 1% to 2% over time compared to the average investor.
3: Reasonable # of funds. Anyone who thinks managing a dozen or so asset classes is very tough as compared to three or four is exaggerating or just parroting boglehead.com talking points.
The Bad
1: Bonds in Roth IRAs? That’d be the last place I’d want to put my low-returning assets. I’d shoot for as much value, small and small value as possible.
2: You’ve got a decent size tilt in your US allocation, but very little value exposure in US and none in non-US markets. And your non-US size tilt is very small. Small/value stocks overseas offer excellent diversification (lower correlations with US large cap stocks) than market-like allocations, along with (much) higher expected returns. You’re missing out here.
3: How long are you going to give BRSIX? I know they shot the lights out from 1997 to 2003 (before anyone heard of them), but it’s very clear they’re having a hard time navigating the micro cap space. Since 2004, they have negative 3F alpha of -2.4% per year, and it’s statistically significant (t-stat of 2.0). There are more efficient ways to engineer a small cap tilt.
The Ugly
Not much here, of course, you’re doing a good job. I’d just say, 25% bonds? You’re DCAing a ton of money every year (good for you). You’d really maximize that effort with a more volatile portfolio (more opportunity to buy at extreme levels). So that means (a) as little in bonds as possible and (b) more exposure to small/value stocks globally.
And, despite the falling interest rates of the last several decades, I’d still suggest you stick with short-term maturities if you must own fixed income – over time they’ll have lower correlation with stocks and less overall volatility, proving to be more effective at dampening stock volatility and providing liquidity when you start spending.
Here’s a comparison of your portfolio with the DFA “Equity” and “Aggressive” models that have been around for decades. You can see, compared to the all-stock, more tilted “Equity” model, you’ve left 2% a year on the table as far back as we can go. Even compared to a similar stock/bond mix (“Aggressive” is 80/20), you’ve left about 1.4% per year on the table. http://bit.ly/2cyClpD
You can use those allocation guidelines to give you a better sense for how to diversify broadly across small/large and value/growth globally, see the allocations here on page 56 in the 2000 DFA Matrix Book: http://services.ifa.com/books/%24versions/dfa_matrix_books/1999.pdf
The Bad
1. Putting high returning asset classes in Roth is just taking more risk. No free lunch there. I could just adjust my AA by 5% and get the same effect. Useful behavioral trick of course to trick yourself into taking more risk, but not free.
2. Decent is in the eye of the beholder. 1/3 of US stocks are considered small cap according to the Morningstar X-ray tool. That’s a pretty huge small tilt compared to the total market. 25% of developed world stocks are in a small cap fund, plus whatever comes with the total market fund. That’s a pretty huge small tilt too. I mean, you can always tilt more, but most tilt far less than I do to small. The value tilt is less. Over 25% of my US stocks are in dedicated value funds, not counting REITs. I opted not to value tilt my international as a way to hedge my bets. I’m not 100% sold on the small/value factors as you obviously are. So I make a bet, but not the farm.
3. Yea, I’m depressed about BRSIX too. I wish someone could figure out how to get those CRSP 10 returns. I moved a Roth IRA from them to Vanguard this year. That’s a half step to leaving already! There’s a decent chance they could be jettisoned in a portfolio revamp. But as you know, staying the course matters even more than the actual course as long as the course is reasonable.
The Ugly
I haven’t been investing “as far back as we can go.” The DFA benefit for as long as I’ve been investing isn’t nearly as significant, and perhaps even negative once you add in a “standard” 1% advisory fee that it generally takes to get DFA access. Again, I’m not 100% convinced of the value of a huge small/value tilt or DFA’s particular methodology, so I hedge a bit. That may cost me, but I’m okay with that.
As far as keeping interest rate risk low with short duration funds, I hear that a lot while those in longer duration funds have been laughing all the way to the bank the entire time I’ve been investing. Eventually you’ll be right at least temporarily, of course, but in the long run, you could very well be wrong! At any rate, the maturity for fully 40% of my bonds is 3 days, so I have a pretty short duration portfolio. The P2PLs probably average 2-3 years maturity and the TIPS funds I use probably average 5-7 years, so I’m not taking tons of interest rate risk. So far that “bet” has been wrong during my investing career.
Jim,
On Roth’s, I was just saying – you hold (some of) the high-expected return stuff anyway, put as much of it in the ROTH as possible. Ideally, you’d put US small value, Int’l small value, emerging markets small cap and value FIRST, but most of those asset classes are out of your reach. If the higher risk pays off, as we’d expect it to, the tax benefits will work even more in your favor. I can’t think of a single reason to put bonds in ROTH IRAs unless you want bonds and have run out of space in all other accounts. ROTHs are gold. You’re wrapping them in garbage.
On your allocation, using indexes in the US, you have a 0.26 tilt to small and a 0.24 tilt to value. I’ll call that “moderate” and kinda leave it there. You’d be better off probably doubling that value tilt (to around 0.40), but again, I’ll leave it. In non-US, you’ve got 80% in “market” portfolios and 20% in a mid/small cap index, and no value tilt. That’s marginal at best. Up to you of course, but I think you might be forgetting about the significant potential diversification benefits from non-US small/value tilts. If I had to choose between tilting in US or non-US markets, I’d choose the later. Quite often I see LESS US tilts than non-US tilts for the tracking error reasons. See my model portfolios, they illustrate this. It’s always interesting to see those obsessed with fees put so little emphasis on expected returns, when the later dwarfs the former.
On getting CRSP 10 exposure, there’s a difference between paper allocations in academic studies and real-world portfolios. I’d focus on the size premium more than some remote decile of the size ladder. Vanguard SC Index, or S&P 600 with a bit more devoted to it should do fine, with less illiquidity and tracking error. Bridgeway has been a disaster. Just be glad you didn’t own it in a taxable account (it used to be a tax-managed fund until that blew up as well).
On “going back,” I’d suggest you look at the longest periods possible, not just some arbitrary 10-year period that fees our recency bias shortcomings. Longest time frame increases the likelihood of avoiding a random 5 or 10-year result that isn’t likely to continue. Since 7/00, the size premium in the US has been +0.26% per month and the value premium has been +0.35%. From 7/1926 to 6/2000 (prior to my example), they were +0.20% per month and +0.39% per month. Almost the same. Obviously the period in my example isn’t biased one way or another, and shows closer to the true properties of the portfolios, except that bond interest rates started much higher and portfolios with long-bonds artificially benefited.
On interest rate risk and what you’ve been hearing…sure, the market can stay irrational for longer than you think. But the simple fact remains, the longest evidence we have shows that anything beyond 5 years in maturity is pointless (no more return, much higher risk), and in times of rising interest rates and inflation (a major risk for investors), even 5 years is too long.
As for being “right or wrong,” (on bond maturities) it’s not about what the results are, it is about the risks you take and whether or not they were worthwhile. You’re willing to take more bond risks (maturity and credit in your P2P lending) but less stock risk (only 75% equities and a mild to moderate small/value tilt). The evidence is firmly in the favor of (a) diversifying equities more broadly, (b) holding as much equity as you can, and (c) if you can’t stomach 100% stocks, add as little of the safest bonds to dampen risk.
You can do it your way, of course, but as I showed, you’re potentially leaving ~2% a year on the table and spending a lot (!) of time on finance stuff to get this lower result.
On international diversification, let me provide an example that spans almost 20 years.
http://bit.ly/2d0JBbU
Portfolio 1 is the traditional US Total Stock/Int’l Total Stock. Portfolio 2 simply replaces the 30% in Total Int’l Stock with a combination of developed value/small/small value and emerging markets large/value/small cap. Higher returns and higher risk you think? Nope. Just the higher returns (+1.4% per year changing JUST 30% of the portfolio). Risk was the same because the diversification benefits swamped higher stand-alone asset class risk.
You’re not gonna get this on a boglehead.com forum, they only care about expense ratios. So I thought it needed to be taught. Most people do international investing all wrong (if they do it at all).
You don’t really believe the value premium is a free lunch, do you? What is your explanation for why this “free lunch” hasn’t been arbitraged away?
Jim,
It’s called Modern Portfolio Theory – a portfolio has less risk than the weighted average of its components. In the case of small/value foreign stocks, as I’ve said, they have not only higher-than-market returns, but much lower correlations to US large stocks. We’ve known about this for some time, here is a 1995 paper that one the Ben Graham paper of the year: http://www.cfapubs.org/doi/pdf/10.2469/faj.v52.n1.1961
The big question is whether this will be true going forward. And lots of Bogleheads spend lots of time arguing about value and small premiums, where they come from, how big they are, whether they’ll persist etc. Very broad group of people once you dig into it. There are even plenty of DFA diehards there like yourself who have swallowed what DFA is selling hook, line, and sinker, for better and for worse.
Jim,
This isn’t a DFA issue, as you seem to want to make it. We’re talking asset allocation and how to improve yours using time-tested principles. You wouldn’t have written an article on your portfolio if you weren’t looking for suggestions, right? I’m applying Nobel Prize-winning asset pricing theory and research to your portfolio. That’s how it should be done.
As to “the big question,” I think this applies to all sources of risk and return: stocks vs. bonds, value vs. growth and small vs. large.
So “the real question” is why you would want to be so much of your portfolio predominately on just one of them (the stock vs. bond mix). You’ve got some small/value exposure (in the US), and very little small and no value exposure abroad (where diversification benefits are highest, as my example above shows: a +1.4% per year better result from changing just 30% of the portfolio).
Historically, the value premium has been as consistent as the equity premium, with the size premium a little less so. And, importantly, they can show up at DIFFERENT times.
This isn’t about swallowing anything, it’s about spending the time to do the research, understand the conclusions, and apply appropriately.
I’ve done the research and analyzed not only the answer, but also the quality of the data, which is a key aspect of it. One must consider not only the likelihood of being wrong, but also the consequences. Nobel prize winners and their ideas have been responsible for some terrible economic outcomes. Take a look at what they say, but take it all with a grain of salt.
https://en.wikipedia.org/wiki/Long-Term_Capital_Management
And no, I don’t really need or want your suggestions on my portfolio. If I wanted them I would have at least sent you an email, or perhaps hired you. I’ve read the same literature you have and clearly come to a different conclusion as to how I wish to structure my portfolio. My faith in factor investing as preached by DFA is clearly not as strong as yours. Is it reasonable to invest as you do? Sure. Is it stupid to invest otherwise? Absolutely not. I’ve discussed how many portfolios can be reasonable here:
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
Why just increase weightings? Why not just put all your money into the single valueyest and smallest stock in the world? When you answer that, you’ll understand why some people prefer not to have as large as tilt as you may prefer. You have to consider not only the probability of being wrong, but also the cost. I’m comfortable with my tilt and can stay the course with it. If the hypervalue/small folks end up being right, I’ll do okay. If the total market folks end up being right over my investment horizon, I’ll do okay. Will you?
As far as risky assets in Roth, once you tax adjust your asset allocation it doesn’t matter. Otherwise you’re just fooling yourself into taking more risk. That’s fine, but it’s not a free lunch.
“Why not just put all your money into the single valuey-est stock in the world?”
OK, we’ve got a bit of work to do here.
First, you want to diversify your portfolio to eliminate all the unsystematic risk, the “bad” risk you don’t get paid to take. You do that by holding hundreds or thousands of stocks. Any random SV stocks will only have “SV-expected returns” but with double or triple the risk (systematic + unsystematic). You can remove a large part of that by holding ALL the small value stocks.
The market portfolio squeezes all the unsystematic risk out of a portfolio. BUT, the market portfolio is dominated by growth-oriented, large cap stocks (by way of its capitalization weighting). Historical returns since 1992: Vanguard TSM = +9.2%, Vanguard 500 Fund = +9.1%.
So, the idea of adding value, small cap and small value asset classes to a large cap or market portfolio is to achieve better diversification across securities (not just putting all your assets in the large cap bucket – why? see 2000-2009!).
Of course, we’ll want to apply these same principles to non-US stocks. First, developed markets. A look at Europe/Asia finds the small to large and value to growth risk/return elements to be in-line with US stocks, but market-like EAFE indexes have much higher correlations to US stocks than value/small/small value. So we can skip EAFE and just buy ILV, ISC and ISV. Next, emerging markets. All stock dimensions (large, value and small) have pretty good diversification to US and even to non-US developed, with continued evidence of small/value premiums. So here, a balance of large cap, value and small cap adds additional diversification and higher-expected returns.
So that’s how you really create a well-diversified portfolio and why it’s done how it is.
As for the cost of tilting, I’d ask you this: what about the cost of NOT tilting? Let’s look at 2000-2009. A negative return for US Total Stock Index, a return of at least +4% to +10% (up to +14% a year on emerging markets value!) for literally every other asset class.
The cost of tilting is this: 1995-1999 – when the US large cap market is going great guns, other asset classes will underperform (but overall, a diversified portfolio will do fine).
The cost of not tilting is this: 1966-1981 and 2000-2009 – you own the one basket that goes 15+ years with no returns and you risk running out of money.
It’s not a very tough choice when you frame it properly.
On ROTH IRAs, it’s pretty simple: they are tax free. Traditional IRAs are tax deferred (with onerous mandatory distributions) and taxable accounts are taxable with the potential for preferred capital gains treatment (and a step-up at death).
Bonds should go first in traditional IRAs (to earn the spread between taxable and tax-free rates and dampen returns for reduced future RMDs), next in taxable. Highest-returning stocks (US small value, int’l small value and EM value/small) should go in ROTH first to maximize tax-free growth.
You can adjust your allocations by after-tax amounts or any other mental accounting trick you want, but these are the basics of account tax consequences and the best order of asset location.
He knows this. The point was taking your logic to an extreme if it was such a good idea, which you then argued against, proving his point. Changing weightings slightly will be very unlikely to change the overall risk adjusted levels or total return at all.
It feels like you’ve never been here before, I’d read the archives before lecturing on types of accounts, etc…again, known and beaten to death. All the basics are there for a good and diversified portfolio, you’re arguing very fine points that definitely will not bring about some large premium than if you were starting from a very mis-allocated portfolio.
I looked again, I’m in error. I thought Jim had put much of his bonds in ROTH IRAs, clearly I’m wrong. My apologies.
I’m not sure why you capitalize every letter in Senator Roth’s last name. Seems odd. What do you think it stands for?
I disagree with your recommendations for asset location. I’m not sure you have a firm grasp of the subject. But if you wish to do it as you do, that’s fine. It’s not necessarily wrong, but it reflects some commonly held beliefs that aren’t completely true.
My only question would be why leave the defined benefit cash balance plan out of your retirement AA?
My cash balance plan my be a bit different from yours but likely not by much. It is aggressive for a DB plan pool invested at 60/40 similar to yours and allows our partners to put in up to $125k/yr (likely more in the future) depending on age and testing. It is quickly becoming a significant part of my overall net worth as it represents 75k out of our total 200k annual retirement contributions.
It just no longer makes sense for us to ingore it for our overall AA, so I now count it as a 60/40 investment (not a bond as many do) and as such it forces me to be more stock heavy in our other accouns to offsets the bonds in the DB plan to maintain our overall 80/20 desired AA.
If your plan will allow for a lump sum IRA rollover when you leave your group, why to you discount from your AA?
I also wonder if you’re willing to commit further to TIPS into retirement. Seems to get real inflation protection, one would need 15-20+% in TIPS, but you seem to be lowering your exposure.
I’ve only lowered exposure once, and only by 2.5% when I added P2PLs. So I wouldn’t say there is some huge trend of lowering.
I ignore the cash balance plan for a couple of reasons- 1) I can’t do anything about its asset allocation or management. 2) It’s a trivial part of my portfolio. We can only put in $30K a year, and last year we closed our old plan and opened a new one. I rolled the old one into the TSP. I think it might be 2% of my portfolio. Safely ignorable given it’s ~60/40 asset allocation isn’t all that different from my overall one. If it was 30% of my portfolio I’d probably feel differently. Not sure there is a wrong answer either way, but some things aren’t worth the hassle.
You mentioned kids IRA
I would like to open IRA for my grandkids, age 6, 11, 16. They don’t work, but get paid for chores (in fact they get paid even if they don’t do chores, aahhh, good to be a kid)
They already have custodial accounts, 529’s and WLI’s
Can you elaborate or do a blog on kid IRA
Do you still ignore your cash balance plan as part of your asset allocation?
My group recently started one. Trying to decide if I should ignore it versus consider it as part of my bonds (it’s buying bonds and target is 4% annual return).
Not sure if you’re talking to Sam or to me, but I still leave mine out of my asset allocation. Mine is actually closing again in a few months and I’ll be rolling it into my TSP. At which point I’ll include it (and probably stick it all in the G fund).
for the 11 and 16 do roth ira
pay them for work/chores/etc and they fill tax returns
invest it all in the stock mkt
Can’t pay them earned income for chores, unless they are doing it for someone else. If they get babysitting money from the neighbor, can definitely include that.
If I’m wrong, and I’d love to be, show me where so I can start including allowance in their Roth!
You’re correct. Can’t pay them for your household chores. You can pay the neighbor’s kid though, and he can pay yours.
do u really think the IRS is going to investigate a teenager’s earnings from babysitting or wherever. They look at the big fish
The child Roth Ira is a guarantee of being a multi millionaire
FWIW-Buffett directed his wife to put 90% of their wealth on his death in the total stock mkt index fund
Well if we are going down that road then make sure you max it out as soon as they have chores.
And yes I do think they investigate as I had 3 of my 5 that needed more “documentation.” Thankfully all of them didn’t earn it from doing chores, so it wasn’t an issue.
You can file taxes with any info you want and there is small chance of audit, but that doesn’t make it legal or, in my opinion, worth the headache and stress if you get caught.
1. If you wanted to simplify, why tilt both Large Value and Small Value? Isn’t that a little redundant and overly complicated? You could just do Total US SM plus Small Value and increase your small value position a little to essentially have the same risk/return expectations.
2. I think its funny that TIPS are big topic of conversation in the comments, perhaps because they’ve done poorly recently and are not currently a very sexy asset class. I’ve always intended on having a small position in TIPS but I don’t have a fund offered in my 403b and for whatever reasons I’ve been reluctant buy any in my taxable account or buy any in my more ‘growth focused’ (so I think) Roth IRAs or HSA – maybe that’s not such good reasoning on my part.
1. Yes. I could. LV is also an asset class perennially on the chopping block.
2. I don’t think TIPS have done all that poorly. I’ve had them for about 10 years and I’ve seen something like 4-5% returns from them. That’s about what I expected. The one year returns are 5.22% and the YTD are 7.26%. Not sure why you think they have poor recent returns. Your expectations might be off if you’re expecting much more than that out of them.
Josh,
When investing, you are generally best off diversifying as broadly as possible. So, when buying value stocks, you want to buy them across the market cap spectrum. When buying small stocks, you want to buy them across the valuation spectrum (save the least profitable, small growth companies). We’ve seen 10+ year stretches with a positive value premium but a negative size premium (meaning large value has beaten the market and small value).
Of course, TSM/SV is simpler, so if you want to make the diversification sacrifice for simplicity, just know there are pros/cons.
TIPS funds are really a superfluous vehicle. Because you aren’t matching a bond to a liability, you don’t have the same level of inflation sensitivity (there’s interest rate risk in a fund that counterbalances the inflation credit) with a fund. And TIPS don’t tend to do as well as nominal bonds in bear markets (see 2008). The answer is to own short-term nominal bonds – less volatility than long-term bonds, less interest rate and inflation risk as well and a high degree of liquidity. Lower returns too, of course, but you can fix that through the stock/bond mix and the level of stock diversification.
This is really helpful. I’m in a similar boat. I have a 403(b), 457(b), HSA, four 529 accounts (2 children, 2 nieces), inherited IRA, taxable account and 2 roth accounts. Accounts are at TD ameritrade, Vanguard, TIAA Cref and state 529 plan. I like personal capital to keep them all tracked and I’m loving my low costs. Just moved my husband’s inherited IRA from a high cost financial planner to VAnguard. Cashed out my husbands old universal life insurance last year and invested it immediately. Funds include: Vanguard total stock market, VG developed markets index, emerging markets index, Total US Bond, Total International Bonds, TIPS, Small cap Value, REIT; 75:25 Stocks to bonds. I enjoy managing my accounts so I don’t mind the complexity. I’m also residency program director in my department and after my other white coat investor colleague gave a lecture on finance a few years ago the residents demand that they have a lecture on finance each year!!
Thanks for posting this personal picture of your investments. I think it should be noted that you never need it this complicated, because many will point to this article for why most people should not be their own investment manager. I’m full in on a Vanguard Target Date Fund and I’m not convinced that your allocation followed perfectly will beat it, let alone one’s ability to not make a transfer mistake or delay along the way OR that one could not make more money by focusing on making more income versus managing these numerous accounts and funds. I think WCI is unique in that researching perfecting his investments also increases his income side so for those just beginning do not be discouraged by this more nuanced article.
There are many roads to Dublin. While you’re looking at my portfolio and saying that’s too complex, too costly, and tilts too much Eric is looking at it and saying that’s not complex enough, it’s worth paying more in fees, and it doesn’t tilt enough.
The main point of the article wasn’t to talk about my asset allocation (which I wrote about years ago and haven’t really changed.) The point is to show how I implement it across my various accounts to hopefully show readers how they can implement their own portfolio across their accounts.
WCI — I find your 529 portfolio interesting. Why 50% international? And do you plan to adjust that with non-equities at any point or plan to keep it 100% equities even as the kids approach college?
I live in MO but am using the Utah 529 plans (we still get a deduction). I’ve been using this asset plan:
http://servowealth.com/resources/articles/529-plans-just-got-lot-better
What are your thoughts on that compared to your allocation?
PEMDoc,
Glad you found my article helpful. 🙂
Compared to Jim’s allocations, mine are much better diversified (esp across large/small and growth/value) and more sensible. Not to mention they aren’t making huge bets on non-US stocks which can be very difficult to stick with when they’re underperforming…and because US and non-US stocks have similar long-term expected returns, there’s very little sense in exposing yourself to that tracking error for what will likely be no benefit (global portfolio volatility is lowest at about 30% int’l).
My example portfolios aren’t ideal (I hate that much in emerging markets large cap stocks and no int’l small value options), but they’re good enough. Especially important is the transition to mostly high quality, short-term bonds at older years.
I think those portfolios are fine.
Why 50% international? Why not? It’s within the range of reasonable. It’s essentially what market weight is for all of the equities in the world.
I am mostly curious why take such a different strategy for the 529 than the retirement portfolio. It seems like differing philosophies at play since the retirement portfolio has far less international. Is it the different time horizons for their use or something else that made you weight them differently?
The main philosophical difference between my 529s and my retirement account is I’m a lot more willing to take risk in a 529 because the consequences of failure are so much less significant as discussed here:
https://www.whitecoatinvestor.com/3-reasons-why-you-can-take-more-risk-with-a-529/
Basically, I just ramp up the risk in the 529-50% small value (Eric would be proud.)
My asset allocation looks like a drunk sailor put it together while sitting below deck during a storm. I don’t have a set method I just move around with bands of 20% into what I view as cheap. I’m 25% EM right now about 30% Intl, 5% intl REIT, the rest dividend paying small value. I know its a bizarre portfolio but I’m going to see how it does for a while before I decide to go the simple route
Changing frequently based on how you feel, what you think is cheap, or what you think will do better in the future is often a recipe for investing catastrophe. Sticking with a reasonable plan, any reasonable plan, generally leads to investing success. Hope things work out okay for you.
How do you keep track of this? If it’s a spreadsheet I’d love to see how it’s put together.
Why did you choose solely the Vanguard Total Stock Market ETF for your HSA account?
It was and is a tiny portion of my overall portfolio and often my default investing option when I see little reason to make things more complex. When I first started it was only $6K or something. It seemed silly to have multiple funds when it was only $6K. Why is it still like that? Inertia probably. I haven’t put enough mental effort into it to decide whether it is worth making it more complex. I mean, how much more complex of a portfolio do you think I need? What I will probably do eventually is just lump it all into the retirement portfolio, of which a big chunk is also…you guessed it…Vanguard Total Stock Market.
I don’t think the complexity is as much of an issue when all the assets are in tax-protected accounts and rebalancing has no tax consequences. And eventually you can roll your two 401ks into a single TIRA. However it does get to be quite a bit more complicated when a larger and larger percent of assets are in taxable accounts and have significant capital gains. Then the ability to rebalance is more challenging without incurring large taxable events. I would be interested in knowing how you are managing your taxable investments. And how it is changing your overall asset allocation and asset class location.
Okay, I’ll try to write about that when I make any significant changes. Thus far my taxable accounts are so small they haven’t had much effect yet, and I may liquidate a good chunk of them to pay off the mortgage anyway.
With the recent management upheaval and changes in lending standards at Lending Club, will you adding/maintaining P2PL allocation for the coming year?
I opened a Roth IRA account at Lending Club this January, and put my $5500 contribution there. I’ve been happy with my returns to date (9% return to date), and had planned to make my backdoor Roth contribution to Lending Club this coming January. Now I am not sure, and am curious if you plan to continue to invest with LC.
Thanks!
Great question. I’ve been meaning to write a post about it, but that would entail actually making a decision, which I haven’t yet.
If people can save enough with retirement and taxable accounts wouldn’t it make sense to max out your retirement accounts exclusively in Bonds/Reits (tax inefficient investments) and leave stock index funds and any left over Bond/REIT (tax inefficient investments) in your taxable account?
Historically, yes. However, in low interest rate environments, you need to challenge this assumption. See Dr. Dahle’s post about this – “Asset Location – Bonds go in taxable!”
https://www.whitecoatinvestor.com/asset-location-bonds-go-in-taxable/
Yea, it’s more complicated than you think Mike. You have to look at both tax-efficiency and expected rate of return. Hi return, tax-inefficient assets (REITs) go in tax-protected accounts. Low return, tax-efficient assets (muni bonds) go in taxable accounts. Everything else doesn’t matter so much.