[Updated on October 3, 2007. Added links to follow-up posts.]
I haven't forgot my promise to Ted and Brad to write about my asset allocation and rebalancing thresholds. I wanted to make a wizard but I gave up, for lack of time and programming skills. Maybe some of those days. Better get this out before I leave for vacation.
Here I introduce my Cascading Asset Allocation MethodTM (CAAM). I googled and I found no evidence of anybody else using that term. So I'm claiming a trade mark on it. :-)
The Cascading Asset Allocation Method involves answering a series of questions. The questions go from the most important to the least important. You can stop anywhere along the way and still have a reasonable asset allocation. The best part of it is that you will understand why you end up with a particular allocation.
Because a picture is worth a thousand words, here's how the method divides up the asset allocation decisions into a series of splits. Click on the picture for a larger view.
You decide how much weight you assign to each arm. The numbers in the picture are what I use for my allocation. You have to come up with your own weights. The higher level splits are more important than the lower level ones. As you go toward the bottom, the splits make less and less difference. At any point, if you are not sure what weights to use, just stop, don't split it. More complexity isn't necessarily better. You might as well stop somewhere in the middle. Here are some examples of the same allocations but not splitting all the way down to the bottom.
| 1 Fund | 100% Vanguard LifeStrategy Moderate Growth (VSMGX) or 100% Vanguard Target Retirement 2015 (VTXVX) |
| 3 Funds | 42% Vanguard Total Stock Market (VTSMX or VTI) 18% Vanguard FTSE All World ex-US (VFWIX or VEU) 40% Vanguard Total Bond Index Fund (VBMFX or BND) |
| 6 Funds | 25% Vanguard Large-Cap Index (VLACX or VV) 17% Vanguard Small-Cap Index (NAESX or VB) 14% Vanguard Tax-Managed Int'l (VTMGX or VEA) 4% Vanguard Emerging Markets (VEIEX or VWO) 20% Vanguard Total Bond Index Fund (VBMFX or BND) 20% Vanguard Inflation Protected Securities (VIPSX) or TIPS bought at auction |
Now, let me explain briefly how I came up with my set of weights on the arms.
- Stocks vs Bonds. Rule of thumb is (100 - age)% in stocks. Benjamin Graham said one should start with 50/50 and adjust up or down between 25% in stocks and 75% in stocks. I chose 60%, slightly above 50/50.
- U.S. vs International. John Bogle said 20%. Some others said 30%. World market is 50%. I chose 30%.
- Nominal bonds vs TIPS. See TIPS Action Plan.
- U.S. Large vs Small. Market is about 25% in small. I chose 40% in small because I work for a large company.
- Developed Countries vs Emerging Markets. Market allocation is 20%. I went along with it.
- Growth vs Value. Because I work for a growth company, I chose to have more investments in value funds. Since a "blend" or "market" fund includes both growth and value, 50% market 50% value is like 25% growth 75% value.
If you want to learn more about asset allocation, you've got to read William Bernstein's excellent book The Intelligent Asset Allocator.
So much for today, I will write about rebalancing later.
P.S. If you haven't completed the reader survey, please do it and help me make this blog better. Thank you.
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8 comments:
Thanks for posting. Very interesting. I like your picture.
What is the difference between the international funds you listed above and the Vanguard Total International Index (VGTSX)? Why wouldn't one just use VGTSX since it contains EMs?
PS - I did the survey
Just came across your site today, lots of great info, I really appreciate your work here.
Could you discuss why the fact that you work and live in the US doesn't (or maybe it does) factor in to your Int'l/Domestic allocation?
Intuitively I would think this should have a bigger impact on your Int'l allocation than you're factoring your employer into your Lg/SM and Gr/Val allocations.
Any response would be greatly appreciated. Thanks in advance.
@Ted: First thanks for filling out the survey. I'm going to use the FTSE All-World ex-US fund because it has everything, including Canada. I think it's a little better than VGTSX because the FTSE fund is supposed to reach deeper into smaller stocks. If I wanted to have either more or less emerging markets than the market has (more EM risk or less EM risk), then I'd split it into one for developed and one for EM.
@anon re: US/international for someone living and working in the US. I'm not immune from the "home country bias." I think the world is becoming flatter though, at least for the large companies which dominate both the US and international indexes. If the economy outside of the US does better, the US companies also benefit. If the US tanks, the international companies also suffer (cf. North Rock in UK). The cost of investing in the US market happens to be lower. So I didn't go overboard in loading up on my international allocation.
Make that Northern Rock, not North Rock.
Interesting. Thanks for posting it, TFB. I'm more interested, really, in your rebalancing triggers, but it's also good to compare allocations. I'm far more aggressive than you in my stock/bond allocation, but less aggressive within my stocks (less small, less international, no REIT). I intend to tilt small, but according to morningstar I'm not doing a good job (10% small-- odd, because according to Vanguard I am 21% small). Anyway, thanks again and I look forward to seeing info about your triggers.
I like the picture, but I would argue that REITs are not a stock, or a bond, but rahter their own, third asset class. As such, I think that the decision to exclude them from a portfolio is unwise. I do not see how a REIT is an equity (though I wishe their dividend streams were taxed that way...)
@Anon, re: REITs. Some experts, like Burton Malkiel, author of A Random Walk Down Wall Street, puts REITs at the top level as a separate asset class together with stocks and bonds. I still put it in stocks because I think REITs are an industry sector and a corporate structure. I've seen regular C-corps converting to REITs and REITs converting back to C-corps. If a stock and a REIT can convert to each other, REIT feels like a stock to me. It just happens to be a stock in the real estate industry.
Good site, just came across it. Like your method and logic - how could I not as it is very similar to mine.
Re REITs and asset classes, to me anything can be another asset class, as long as it provides diversification by being un- or negatively-corrleated with other asset classes.
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