Some readers asked me to write about my asset allocation and rebalancing thresholds. 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 you will 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.
You decide how much weight you assign to each arm. The numbers in the picture are what I would use for my allocation if I go all the way to the bottom on each branch, which I don’t always do. For instance right now I don’t split US small cap; everything is in US small cap value. Nor do I split international stocks; everything is in a total international stock market index fund. I’m also flexible in fixed income: I have munis, CDs, and I Bonds.
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 Index Fund (VTSAX or VTI)
18% Vanguard Total International Stock Index Fund (VTIAX or VXUS)
40% Vanguard Total Bond Index Fund (VBTLX or BND) and/or Vanguard Intermediate-Term Tax-Exempt Fund and/or CDs
|6 Funds||25% Vanguard Large-Cap Index Fund (VLCAX or VV)
17% Vanguard Small-Cap Index Fund (NAESX or VB)
14% Vanguard Tax-Managed Int’l Fund (VTMGX or VEA)
4% Vanguard Emerging Markets Stock Index Fund (VEMAX or VWO)
20% Vanguard Total Bond Index Fund (VBTLX or BND) and/or Vanguard Intermediate-Term Tax-Exempt Fund and/or CDs
20% Vanguard Inflation Protected Securities (VAIPX) and/or individual TIPS and/or I Bonds
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. 50:50 sounds good but I’m flexible.
U.S. Large vs Small. Market is about 20% 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.
For rebalancing, see +/- 5% Rebalancing Bands.