I often tell people to choose a reasonable asset allocation (written investing plan) and stick with it. In this regard, the investor matters far more than the investments. Of course, that requires that the investing plan first be REASONABLE. Those of us who have been doing this for a long time can tell at a glance whether a plan is reasonable or not. Sure, we’ll bicker about whether you have too much in one asset class, too little in another, or perhaps whether you just have too many asset classes altogether. But there is plenty of room for disagreement among reasonable people.

However, there are LOTS of portfolios out there that simply are not reasonable. That was the point behind my famous 150 Portfolios Better Than Yours post. Anybody who thinks there is only one way to invest successfully is simply ignorant. If you pick something reasonable and fund it adequately, it is highly likely to reach your goals.

Despite the fact that a veteran can recognize “reasonable” vs “unreasonable” (a bit like “sick” vs “not sick” in medicine) at a glance, there are plenty of newbies who really don’t know the difference. So today I’m going to try to teach them. And what better way than a top ten list?

10 Ways to Know if Your Investment Plan is Reasonable

If you’re wondering if your investment plan is reasonable, ask yourself these ten questions.

# 1 Can You Stick With It?

An asset allocation can be a pretty personal thing, and that’s mostly because of one factor–we all have different tolerances of the various risks in investing. An asset allocation might be reasonable, but that doesn’t mean it is reasonable for you. For example, a portfolio that is highly tilted toward investing “factors” like small and value is a bad idea if you can’t handle significant tracking error away from the S&P 500. Likewise, if you’ll bail out of your long-term bond portfolio after a rapid rise in interest rates.

# 2 Are You Taking Enough Risk?

Here’s an example of an unreasonable portfolio:

  • 25% Gold
  • 25% Whole Life Insurance
  • 25% Bonds
  • 25% CDs

Why is it unreasonable? Mostly because you aren’t willing to save 50% of your gross income for an entire career. The expected returns on this sort of a low-risk portfolio are so low that it is unlikely to provide for the financial goals of most people. I’d expect this portfolio to keep up with inflation over the long run, but that’s about it.

# 3 Are You Taking On Too Much Risk? 

investment plan

 Uncompensated risk in action.

Here’s another unreasonable portfolio:

  • 25% Apple Stock
  • 25% in a single muni bond
  • 25% in Ethereum
  • 25% in your brother in law’s small business

Believe it or not, a lot of people own portfolios like this. If it isn’t patently obvious why this portfolio is unreasonable, you should not be managing your own money.

Apple might be a great company (don’t ask me) but putting 25% of your portfolio into ANY single company that you are not the CEO of (and even then if you can avoid it) is dumb. It’s just a dumb investment. You’re taking on uncompensated risk.

Same thing with a single bond. No, muni bonds don’t default very often, but close to zero is not the same as zero.

I’m not a big fan of cryptocurrencies as I think they’re speculative instruments, but if you are going to speculate in them it seems foolish to me to bet on a single one. Better yet, keep any speculative bets to a much smaller percentage of your portfolio.

And if you thought a single stock was risky, you might want to take a look at the failure rate for small businesses: 20% go out of business in year one and by year ten 70% are out of business. It’s just not an appropriate place for such a big bet. Diversification is a key principle of investing. Always has been. Always will be.

If your real estate portfolio is highly leveraged, you have the same issue. Leverage works, but it works both ways. If your portfolio can’t handle all expected events and most unexpected events, you probably need to make a change. How much is too much leverage? Well, consider that the pros generally put down 25-35%. There’s probably a good reason for that.

Benjamin Graham, the mentor of Warren Buffett, classically taught that you should keep your stock to bond ratio between 25/75 and 75/25. There is a lot of wisdom there in the idea that you never want to take too much or too little risk.

# 4 Is It Overly Complex?

Consider this portfolio:

  • 3% Bitcoin
  • 2% Ethereum
  • 5% Gold
  • 6% Large growth stocks
  • 8% Mid cap value stocks
  • 5% Small cap value stocks
  • 4% Small cap growth stocks
  • 9% Tech stocks
  • 4% Chinese stocks
  • 4% Spanish stocks
  • 3% Frontier Market Stocks
  • 11% European Stocks
  • 9% Japanese Stocks
  • 4% short term corporates
  • 6% long term treasuries
  • 3.5% cash
  • 1.5% Hard money loan funds
  • 4% in a crowdfunded apartment building in Houston
  • 2% IBonds
  • 2% TIPS
  • 5% International Mortgage REITs

21 different asset classes and at least that many holdings. This is the definition of rebalancing hell. I think there is great benefit in going out to three asset classes and significant additional benefit in going up to 7. Perhaps a case can be made for up to 10 asset classes. Beyond that, you’re just playing with your money. You’re wasting too much time and generating too much in commissions, fees, expense ratios, and other costs.

Remember there are very sophisticated investors using a “3 Fund” portfolio or even a single target retirement or life strategy fund for their entire portfolio. You don’t need this kind of complexity to be successful.

# 5 Is It Overly Concentrated?

Consider this portfolio:

  • 20% TIPS
  • 20% Total Bond Market
  • 10% Total Stock Market
  • 10% Total International Stock Market
  • 40% Small Value Stocks

There is some data out there that small value stocks are likely to outperform the overall market in the long run. But the data is retrospective (and thus highly subject to data mining) and quite limited. Plus, this is investing, not physics. The actions of an incredibly complex system are not easily explained and change over time, especially in response to their own measurement. Betting 2/3rds of your stock portfolio on just 2% of the market/economy is not the most brilliant of moves. Even if the bet works out, will you be able to stick with it long enough to see that day?

# 6 Are You Going To Get Killed on Taxes?

Let’s say you are in the highest tax bracket and your portfolio is 90% taxable and only 10% tax-protected. This portfolio might not be wise:

  • 20% Large Value Stocks
  • 20% Mid Cap Value Stocks
  • 20% Hard Money Loans
  • 10% TIPS
  • 20% REITs
  • 10% Junk Bonds

This is an incredibly tax-inefficient portfolio. It just isn’t right for a mostly taxable investor. Sure, you don’t want the tax tail to wag the investing dog, but this person would come out so much further ahead if their portfolio were primarily made up of tax-efficient investments like broadly diversified total market index funds, equity real estate owned directly or via funds/syndications (where income is sheltered by depreciation unlike in publicly traded REITS), muni bond funds, and I Bonds. Yes, you could have one or two tax-inefficient small asset classes placed into your tax-protected accounts, but that’s about it.

# 7 Are You Leaving Free or Nearly Free Money On The Table?

Imagine you love real estate and alternative investments. Maybe you want to avoid mutual fund investing all together but that’s all that your 401(k) offers. By not investing there, you not only may leave part of your salary on the table in the form of the 401(k) match, but you are likely leaving a ton of tax and asset protection benefits there too.

Another way that free money gets left on the table is when you have two uncorrelated asset classes with similar expected returns. By only investing in one, you are leaving the “rebalancing bonus” on the table. Perhaps the classic example of this is someone who does not wish to invest in international stocks at all. I suppose if you truly believe that international stocks will significantly underperform US stocks over your investing time horizon this isn’t a crazy thing to do, but given the evidence to the contrary, you’re likely leaving money on the table by doing so.

# 8 Can You Get Similar Performance at Lower Expense?

Imagine two mutual funds that invest in large cap stocks. In fact, let’s imagine two separate 500 index funds. There is the Vanguard fund, with an expense ratio of 0.03% and there is the Rydex fund, with an expense ratio of 2.41%. What would you expect if you plotted out long term performance of these two investments?

Well, over the last 10 years (as of 12/16/2019) the first has annualized performance of 13.40% versus 10.71%. I’m not one to tell you to choose investments purely based on past performance, but when there is a really good reason for that lower performance, you probably ought to pay attention.

It turns out the best predictor of future long-term mutual fund performance among funds that invest in the same asset class is….wait for it…..drumroll please…..expense ratio. That’s right. Cost matters, and it matters a lot.

# 9 Does It Pass The EyeBall Test

Ask yourself three questions:

  • Would you put your parent’s money into this asset allocation?
  • Would any reasonable person argue vehemently against it?
  • If your best friend came to you with this portfolio, would you try to talk him out of it?

Often we can justify some investment risks to ourselves because we find the investments interesting or feel we can tolerate them better than the average bear. But when you’re talking about your parents’, friends’, or clients’ money, you probably think differently. Imagine you have a fiduciary duty to yourself, and act accordingly.

# 10 If You Fund it Adequately, Will It Be Successful? 

Imagine you put $100K per year into this portfolio? Will you have a very high likelihood of successfully reaching your goals? At the end of the day, the purpose of investing is to reach YOUR goals, while taking as little risk as possible. Match the investments to the goals, rather than vice versa, and you’ll likely be a lot happier with the results.

What do you think? How do you define a “reasonable” portfolio? What are some examples of portfolios you think are unreasonable? What does your portfolio look like? Comment below!