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How to construct your own asset allocation

Trying to settle on an asset allocation is a classic cause of analysis paralysis. Financial industry talk of efficient frontiers, mean variance analysis and allocations customised for your unique circumstances can lead you to believe there’s a perfect recipe out there – some financial equivalent of the Ancient Greek’s golden mean.

Sadly, you can only know your ideal asset allocation in retrospect. That’s because nobody can predict with any degree of certainty which combination of asset classes will deliver the best returns after one, ten, or 20 years.

The proper goal of asset allocation is to pick a diversified combo of investments to see you proud in most circumstances. The mix should suit your:

  • Time horizon – might you be forced to sell up at the worst possible moment?

In a minute I’ll run you through a simple method to create a robust asset allocation. We’ll consider what questions you’ll need to ask yourself along the way and some of the rules of thumb you can use to narrow down your answers.

But before that we need to do some spadework.

Asset allocation preparation

You need to know what you’re investing for. Specifically, some hard numbers:

  • In how many years will you need it?
  • How much will you save towards your goal?

Spend some time thinking about those numbers. The result will be a plan that can be adapted to any investment goal.

Don’t worry if your numbers are a little hazy. Investing is like piloting a ship through the fog. We will make a few course corrections along the way. For now we just need to know roughly where the land lies.

You don’t have to consult your local mystic to work out your return number, either. We’ll get that from the historical record and a smorgasbord of sources that have analysed current valuations. This number will be wrong, but it’s the best we can do and is no more likely to be wrong than anyone else’s best guess. (I’ll write more about this in my next post).

Your return number will be heavily influenced by the combination of equities1 and bonds2 that suits your risk tolerance. Together, equities and bonds are the rocket fuel and crash bags of a diversified portfolio.

Equities are your rocket fuel and bonds will break your fall

  • Equities generally deliver decent growth, but occasionally they destroy value like a shredder that suddenly grabs your fingers.
  • Bonds generally offer stability and low growth, and help to cushion your portfolio when your equities fall.

Traditionally, 100% equities is the preserve of beings with an emotional temperature near Absolute Zero. Meanwhile 100% bonds is reserved for timorous burrowing creatures who cannot bear loss of any kind.

Most people lie somewhere in between.

Your place on the spectrum is impossible to know with any confidence until you’ve received your first shoeing in the market. The industry uses risk profiling tests in the absence of other evidence, or you could try the risk tool here on Monevator. We’ll also offer an even cruder approach below.

Ultimately, the amount you invest multiplied by the compound return you receive will equal your big number in X years.

If X years is likely to be less than ten, then you’d be very unwise to commit all to equities. More on this below.

Beware too that if your required return suggests an equity allocation above your risk tolerance – or higher than the expected rate of growth – then you’re heading for the rocks.

Rather than ignoring the red warning light and slamming the risk lever to Max Equities while hoping not to crash, you’d do better to save more, reduce your big number, or plan to take longer to reach your destination.

Choosing your equities

Most people must invest in equities because their goals require a rate of growth they’re unlikely to get from bonds, cash, or any of the gentler asset classes.

Equities are inherently risky, so passive investors diversify as much of that risk away as they can by investing in the broadest pools of shares possible.

By doing so, we avoid taking bets on individual companies, industries, countries or regions that could sail down the Swanee.

Instead, we invest in the most diversified equity line up available – the World Stock Market, which currently looks something like this:

Region Allocation (%)
North America (US & Canada) 52
UK 8
Europe 17
Pacific inc Japan 13
Emerging Markets 10

Source: iShares MSCI All-Country World Index (ACWI) ETF

This diversified global portfolio represents the aggregate buy and sell decisions of every investor operating in the world’s major stock markets.

In other words, it’s the best approximation we have of where Planet Earth’s finest investment minds are allocating their capital. As we probably don’t know any better than them, we should do the same.

If you’re a 100% equities buccaneer then you could do worse than replicating that allocation, which is easily done by putting your money into an All-World ETF like Vanguard’s VWRL.

However, few investors want nor need nor can handle an all-in equity allocation.

Bring on the bonds

The point of bonds is to dilute the riskiness of equities. So we want the least volatile bonds around:

  • Government bonds – ideally short-maturities, conventional, or index-linked.
  • From your home country – gilts for UK investors.
  • That’s assuming they’re investment grade – UK gilts are.

What percentage of your portfolio should be devoted to bonds? Again, there’s no correct answer to that question. It depends entirely on your personality, goals and financial situation.

But we can throw a rope around your number using some general principles and rules of thumb.

Remember, we’re only investing in equities because we need the growth they offer over the long term. If you owned an orchard of money trees and waded through bank notes like autumnal leaves then you wouldn’t have to bother with all that nasty stock market crash business.

So if you don’t need much growth (say just 0.5% to 1% real return per year over the next ten years) then you can hugely reduce your reliance on equities.

In other words, if you’re more interested in capital preservation, then a strong allocation to shorter-dated conventional gilts and index-linked gilts makes sense.

Associated rule of thumb: 100 minus your age = your allocation to equities.

If you need the money soon then equities are a big risk. And by “soon” I mean anytime in the next ten years.

Equities have a 1-in-4 chance of returning a loss inside any five-year period and a 1-in-6 chance of handing you a loss within any given ten years, according to the analysis of Tim Hale in his superb book Smarter Investing.

So do not allocate 100% to equities if you will need all of your money within that period.

Associated rule of thumb: Own 4% in equities for each year you’ll be investing. The rest of the portfolio is in bonds.

If you don’t need the money at all then you can happily increase the risk you take.

For example, if your living expenses are amply covered by income streams such as a defined contribution pension and the State Pension then you could easily up the equity allocation as a proportion of your assets.

If equities plunge in value then no matter, you can ride out the dip and enjoy the upside whenever a recovery comes.

However, your risk tolerance is the house that rules all.

Risky business

You can have all the money in the world, but if you can’t bear to see a chunk of it consumed by a crisis of capitalism then you should avoid a large dose of equities that could cause you to panic at the worst possible moment.

The nightmare scenario with any asset allocation is that it’s too risky for you. If you sell when markets plunge you’ll lock in losses and permanently curtail your future returns.

Therefore an untested investor is advised to think conservatively – opt for a 50:50 equity-bond split until you know yourself better.3

Sadly, your risk tolerance is a moving target. It’s known to weaken with age and the amount at stake. Therefore even a tried-and-tested investor should reassess their allocation from time to time and consider lifestyling to a lower equity allocation as they age.

Associated rule of thumb: Think about how much loss you could take. 50%? 25%? 10%? Write down the current value of your investments. Cross that figure out and replace with the amount it would be worth after enduring your loss.

Could you live with that if it took 10 years to recover your original position? Limit your equity allocation to twice the percentage amount you can stand to lose.

William Bernstein, in his wonderful book The Investor’s Manifesto, provides handy instruction on how your risk tolerance might modify a rule of thumb like “your age in bonds”:

Risk tolerance Adjustment to equities allocation Reaction to last market crash
Very high +20% Bought and hoped for further declines
High +10% Bought
Moderate 0% Held steady
Low -10% Sold
Very low -20% Sold

The rules of thumb aren’t magic amulets. They ward off no future disaster. They are only road traffic signs that will hopefully guide you to the right destination at a relatively safe speed.

Here’s one final rule of thumb: the 60:40 moderate equities and bonds split. It’s become the default industry standard for the ‘don’t knows’ or ‘Joe Average’.

Inflation, deflation, and cash

Remember that conventional and index-linked bonds perform different roles.

Generally, index-linked bonds protect you against inflation and conventional government bonds perform well during recessions and times of deflation. Many people split their fixed income allocation 50:50 between the two.

You can also devote a proportion of your bond allocation to cash.

Cash is vital for short-term requirements– such as paying the bills – but as an asset class it has historically under-performed bonds over the long term. (Nimble private investors prepared to continually chase the highest rates may do far better than average with cash, however.)

Press play to continue

Once you’ve thought through your equity/bond split, you’ve made the asset allocation decision that will have the biggest impact upon your ultimate returns from investing.

The hard work is potentially over. If you like, you can now draw a line under the process – or outsource the fine details to a one-stop, fund-of-funds like Vanguard’s LifeStrategy series

Keen to go further? Then you can carry on tweaking your asset allocation in search of further diversification and return premiums.

Fine-tuning with property, risk, and global bonds

The following advanced moves should all be taken from the equities side of your allocation.

Global property is the halfway house between bonds and equities in terms of growth and volatility. The performance of commercial property isn’t highly correlated to either of the main two asset classes so it adds a smidgeon of extra diversification.

Allocations to property generally lie between 5 and 20% of the portfolio – typically 10%.

Risk factors are the few slivers of global equities that have a long track record of delivering market-beating growth. They also have a long history of delivering increased volatility, and there’s no guarantee they’ll continue to perform well in the future.

Well known risk factors are value equities and small caps. If the future looks like the past then you might expect a factor like small-value to deliver an extra 1% real return per year (after fees) over its equivalent broad-based index, such as the FTSE All-Share.

But you’d also be throwing in an extra 20% more volatility. Be sure you can handle the risk, or compensate by increasing your bond allocation.

To add risk factors to your asset allocation, divide your regions into broad market, value, and small cap allocations.

For example, 20% UK equity allocation becomes:

  • 10% UK equity
  • 5% UK value
  • 5% UK small cap

Better still, the value and small cap slices can merge into 10% UK small-value.

Global corporate bonds of varying yields and maturities add an extra source of diversification, but should be taken from the equities side due to volatility concerns. Consider a 10% – 15% allocation.

In Smarter Investing Tim Hale allows for an allocation to the most stable corporate bonds – short-dated, domestic currency, investment grade – to be taken from your fixed income allocation rather than equity, as they are not unduly volatile.

Finally older investors may wish to tilt their equity allocation towards their home territory to reduce currency risk. The downside is you’ll be taking a bigger punt on your domestic market.

Further ideas

It’s absolutely fine to carve out your allocations in big 5 – 10% blocks. The odd fiddly percentage point here and there will make little difference to your final score.

I’d avoid adding so many sub-asset classes that you end up with a raft of sub-5% allocations. It just adds unnecessary complexity for negligible gain.

Most investors use model portfolios to help firm up their ideas. Some we’ve written up include:

You’ll find there’s a good range of low cost index trackers to cover almost any of the asset classes you might choose.

Take it steady,

The Accumulator

  1. Equities are shares in companies, hence their alternative name of shares. Americans call them stocks. []
  2. Bonds are debts. By buying them, you effectively lend a government or company money. It pays you interest and (usually) returns a capital sum after a fixed period of time. []
  3. The Investor has even suggested 50:50 equity-cash for new investors. []

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{ 40 comments… add one }
  • 1 vanguardfan January 28, 2014, 11:25 am

    great summary. Second the request for some more reviews of all-in-one fund or ETF options (if they exist beyond Vanguard Lifestrategy!)

  • 2 Paul S January 28, 2014, 11:42 am

    The statement “Equities have a 1-in-4 chance of returning a loss inside any five-year period and a 1-in-6 chance of handing you a loss within any given ten years…..” gives the impression that such losses are random events that can strike at any time. Examination of the data shows a totally different picture.

    Shiller’s US data shows that in the 132 10-year periods from 1871 to 2003 there were 16 negative periods (we are talking total real returns here). This is about 1-in-8, which is not too dissimilar to the 1-in-6 quoted for the UK market. However, they are far from randomly occurring. They are confined to three distinct groups……….

    There were five consecutive years that produced a 10-year loss all of which periods included World War 1.

    There were nine consecutive years that produced a 10-year loss. This was the Great Inflation and followed the excesses of the early 1960’s. From 1964 t0 1982 US inflation averaged 6.5%pa with a peak of over 13%. In the UK it went over 20%. Equities suffered in this environment however most other assets suffered far worse. Cash bombed and bonds melted away. Almost everything lost real value but equities lost less.

    The final period…..two consecutive years producing 10-year losses. As this resulted from the dot.com madness and subsequent crash and includes the 2008 financial crisis it was hardly a random event.

    The evidence is that, except for rare periods of craziness, equities produce remarkable steady growth viewed over a 10-year period.

  • 3 Demeter January 28, 2014, 12:12 pm

    The major problem for me regarding the all world funds is that they’re grossly overweight to the US.

    A Total World / All Stocks ex US would be perfect. They’re available in the US but not here.

    And it would be nice to see a Russell 3000 index fund in the UK too, it’d fit nicely with a total world ex US fund.

  • 4 Neverland January 28, 2014, 12:19 pm

    @Paul S

    There is a lot of survivorship bias in quoting US stockmarket data

    In the period from 1871 to 2003 the USA went from being an emerging market recovering from a hugely destructive civil war to be the dominant and unrivalled superpower on earth

    A look at the German, Austrian, Chinese or Russian stock markets in the same period would tell a very different story about equity risk

  • 5 Robert January 28, 2014, 12:53 pm

    As always, an excellent article. But in the “William Bernstein” table, you seem to be saying that if you have a very high tolerance to risk, you should increase your bond allocation by 20%. Er….

  • 6 Paul S January 28, 2014, 1:51 pm

    Germany and Austria fought and lost two world wars. Russia disintegrated through war and revolution and China fought a long war leading to communist revolution. Bar war and revolution being bad for equity markets I am not sure what is to be learnt from those sources. I don’t imagine the Russian, Austria, Russian and Chinese bond markets prospered much either.

  • 7 PC January 28, 2014, 1:53 pm

    Excellent article (again). Thanks.

    The only point missing for me (in the preparation part) is inflation – I guess it’s covered under returns, but it has an impact on my own asset allocation in its own right.

    Not that I have any special insight – inflation in the last couple of years has turned out much lower than I expected.

  • 8 The Accumulator January 28, 2014, 2:16 pm

    @ Robert – [slaps forehead] Thank you for pointing out my schoolboy error! Have corrected ‘bonds’ to ‘equities’. Cheers!

    @ PC – that’s a fair point. Equities, property and index-linked bonds are the main guards against inflation. Not hyper-inflation, but regular ol’ invidious inflation over time.

    @ Paul S – That’s an interesting walk through the historical record and I agree with you that over 10 and 20 years we would expect equities to deliver growth. Not steady growth, but growth. I don’t think the term random is helpful in this context. Was WWI a random event? Many fine historians trace the course of events that led to war but few would suggest it was inevitable. And while some foresaw a European war many more only saw it in retrospect. Moreover, who could foresee the consequences? Craziness happens, the world is oft derailed and most are caught up in the event. Don’t think you can see the train coming.

  • 9 PC January 28, 2014, 2:56 pm

    Sometimes there’s a hint of a train coming .. but not of the exact timing or of how things will play out.

    For example, there was so much extreme craziness going on in the dot com boom at the start of 2000 that it became an accident waiting to happen. That might have been an exception though ..

  • 10 Neverland January 28, 2014, 4:30 pm


    Lots of craziness going on in the tech market right now….$3.2bn for a smoke detector manufacturer…..$1bn for a company with a photo app (what s steal apparently)…$40bn for Twitter……$1bn for justeat.co.uk

    Pretty soon these little sums all add up

  • 11 Tony January 28, 2014, 10:32 pm

    Great article. One of the best summaries of Asset Allocation I have read. Thank you.

  • 12 PC January 29, 2014, 10:19 am

    I guess I’m guilty of a bit of tactical asset allocation 🙂 Hadn’t heard the term until I came across this article via abnormalreturns.com http://www.nytimes.com/2014/01/28/your-money/forget-market-timing-and-stick-to-a-balanced-fund.html

  • 13 Muller January 29, 2014, 10:32 am

    Vanguard have announced changes to their LifeStrategy funds from 1 February. The allocation to UK equities is being reduced from 35% to 25% in the case of the 100% equity fund. Secondly, they are introducing global bonds (hedged back to sterling) and significantly reducing the holdings in UK gilts, investment grade bonds and index linked gilts.

    Some comments/thoughts on this would be welcomed.

  • 14 IverPotter January 29, 2014, 12:21 pm

    Question – how does income drawdown affect the sort of time-based asset allocations discussed here? In other words how do you allocate according to a first period of full investment moving into a tapering period where you remain invested, possibly until the end of life, but starting to draw an income?

  • 15 vanguardfan January 29, 2014, 1:15 pm

    @muller – thanks for the detail about the changes to LS funds. I emailed Vanguard to ask for the change in asset allocation and was told I needed to ask my broker – where did you find the information? Have you seen any justification from Vanguard?
    I am not sure what to think. I found their original justification of the choice of asset allocation convincing, as they appeared to have a rationale, but this leaves me wondering what has changed which makes this allocation no longer the ‘best’? Why tinker?
    Also, most commentators recommending passive portfolios would recommend government bonds for maximum security, and that risk should be taken on the equity side. I’m not sure the Vanguard bond allocation is what I would choose for myself (which would be more along the lines of TA – 50/50 index linked/conventional).

  • 16 vanguardfan January 29, 2014, 1:50 pm

    I found this document outlining the rationale for the previous asset allocation:


    It indicates that a move to 20% UK equities is supported by the evidence they present, but they do rather argue against adding currency hedged global bonds….

  • 17 The Accumulator January 29, 2014, 2:56 pm

    @ Muller – it’s hard to comment without seeing the allocations. A number of institutions and commentators have shifted position in view of the low prospective returns from bonds.

    Global bonds are now being seen as an additional source of diversification. If they’re hedged back to Sterling then currency risk is out of the equation so it comes down to their rating. AA – AAA government bonds hedged back to Sterling probably won’t offer much in terms of return or extra volatility.

    Lower rated government bonds and corporate bonds may offer extra return and almost certainly more volatility. I still subscribe to the view that bonds are there to provide stability above all, but it’s a hard sell given that everyone thinks bonds are on a losing streak.

    @ Iver – here’s two pieces to help you answer that question. Again, the answer lies more in your personal circumstances but here are some guide ropes (contradictory ones too!):

  • 18 BeatTheSeasons January 29, 2014, 5:15 pm

    @ Muller

    Thanks for the info. I think I’ll stick to my own DIY asset allocation rather than take a chance that someone else will start tinkering with my portfolio without my knowledge.

    Now, there’s an investing risk I hadn’t considered before!

  • 19 Muller January 29, 2014, 6:28 pm

    @vanguardfan – I found the LifeStrategy changes in a Vanguard press release for professional investors on a site I cannot now find. The justification is that ‘a global portfolio model provides the optimal forward-looking investment option…being overweight or underweight in particular segments of the global market puts investors at risk of performance results which may be different from the global market average’. But the funds do retain a marginal overweight in favour of GBP denominated securities.

    @ The Accumulator – the 100% equity fund will be 25% UK, 67% global developed and 8% emerging markets. The 20% equity fund will be 11% UK gilts, 7% UK investment grade bonds, 6% UK index linked gilts and 56% global bonds. This apparently reduces the UK denominated bond holding from 100% to 35%

  • 20 Charlie January 29, 2014, 8:00 pm

    There’s a little info on LifeStrategy asset allocation changes here:

  • 21 Jonny January 30, 2014, 12:13 am

    A really interesting article, and one I wish I had 3 years ago when I started my investing journey.

  • 22 The Accumulator January 30, 2014, 9:36 am

    Thanks Charlie and Muller. The diversification principle is sound and hedging back to Sterling (at low cost) takes out the main argument against holding foreign bonds. Obviously it would be good to see who’s bonds they’re investing in, but ultimately they’re applying the same logic as the World Equities Portfolio – invest in line with the collective brains of global capitalism.

  • 23 dearieme January 30, 2014, 2:44 pm

    If you hold, say, a Vanguard 40% fund in an ISA, does that mean you’re effectively collecting the interest on the foreign (and UK) bonds tax-free? Presumably, though, you’re not avoiding foreign withholding tax on the equities?

  • 24 Dave P January 30, 2014, 7:07 pm

    Bonds schmonds. I had part of my portfolio invested in an index linked bond fund for the last 4 years. When I sold my bond allocation a few months back, I got back almost exactly what I’d put in. So for every £1000 I put in, I got £1000 back. Didn’t even keep pace with inflation. And I’d been exposed to the risks of the bond market, bond bubbles etc etc. So plenty of risk, but bugger all reward. By contrast, every £1000 I’d invested in cash had returned 3-4% per annum with (almost) no risk and so was worth around £1150. Of course, my trackers had returned vastly better than that, but that’s not the point – we’re talking about the low risk portion of the portfolio here. No, as far as I’m concerned, for the private investor cash beats bonds for the low risk investment part of their portfolio. These days, I’m trackers and cash, and quite happy to be so.

  • 25 The Investor January 31, 2014, 10:54 am

    @Dave P — No argument with trackers and cash, I’ve suggested similar is a great combination myself.

    However your overall comment is a IMHO a good example of how *not* to evaluate an asset class.

    The fact that you didn’t get much of a return over some arbitrary period of time tells us very little about the long-term benefits of the asset class, or more importantly about what could come from it in the future.

    It also tells us nothing about how you would have fared if, for example, another big US bank had been allowed to fail and the world really plunged into a deep recession as a result, which easily *could* have happened. The risks you faced as a government bond investor were small by comparison in that instance, especially as the big risk faced by bond investors (inflation) was countered by the fact that you’d plumped for index linked bonds.

    Which, incidentally, you bought at a time when they were expensive. Again, no argument with that, but one day they will be cheap again. Never say “never again”. 🙂

  • 26 PC January 31, 2014, 11:22 am

    To discipline myself I like to imagine what asset allocation I’d choose if I had to leave it untouched for 10 years ..

    In reality it’s more like 1 year but I find it removes the worst temptations to dabble

  • 27 Bluejeansman February 4, 2014, 4:10 pm

    Yet another superb article from monevator. Timely one as well for me personally, as I was thinking about my own asset allocation. appreciate an opinion on my AA.

    I am based in UK but have money in US (old 401k, Vanguard, etc) and UK (ISA, SIPP etc). I dont want to move my US money into UK right now due to various reasons. I have researched the tax treatment and I can keep the US and UK money separate without punitive tax treatment. I want to keep this post brief.

    What I have done is : taken each of my stock mutual funds in US and UK, and observed its exposure to world stock market. For example : Vanguard UK Vanguard FTSE Developed World ex-U.K. Equity Index(VVDVWE) is 56% US, 44% rest of developed world. I have done this for each of my mutual funds, so I know my current world stock exposure.
    It is currently as follows :
    Current stock/bond/cash split I have is 60/10/30. (my intended AA is 60/40 stock / bond).
    Within Stocks/REIT : US:42%, UK:40%, Developed-RestOfTheWorld:14%, Emerging:2%, REIT/PropertyFunds:2% : Total=100%

    I am planning to implement my AA as follows : (leave emergency cash out of the picture)
    Keep stocks/bonds ratio as 60/40.
    For stocks (including REIT), go with :
    US:30%, UK:26%, Developed-RestOfTheWorld:25%, Emerging:9%, REIT/PropertyFunds:10% : Total=100%
    Bonds : Pack my bonds inside tax-sheltered. (US 401K, US Roth, UK SIPP, ISA etc)
    On my US tax-sheltered bonds part, go with 50% Vanguard Total Bond market, 50% TIPS : Provider : Vanguard US.
    On my UK tax-sheltered bonds part, go with 45% Vanguard UK government bond index, 45% UK inflation linked gilts, 10% UK investment grade bond : Provider : Vanguard UK.

    I wanted an opinion tho if the AA (inside each of stocks and bonds bucket) looks okay ? Again, I am happy with 60/40 stock/bond split.

    Thanks !

  • 28 Bluejeansman February 4, 2014, 4:31 pm

    @Dave P :

    Dave P : yes, cash may return 3-4%, however, is that after or before taxes ? In general the advice is to place the bond part of the portfolio in tax-sheltered bucket.

    Regarding returns, following is the performance summary of Vanguard UK govt bond index fund :
    (From : https://www.vanguard.co.uk/uk/mvc/loadPDF?docId=2048 )
    2010 7.37 %
    2011 17.02 %
    2012 2.74 %
    2013 -4.21 % (negative)

    also from John Norstad’s page (famous US financial blogger, the following being an investing classic article ) :

    For US Bonds, 1986 – October 2001
    Annualized Total Return of Vanguard Total Bond Market Index Fund was 8.0%

    also, during a financial crisis, dont bond funds go up in value (due to flight to safety etc) ?

    I have also been not too happy with bond returns, however, I have read that bonds beat cash over the long run, and especially since you can place them in tax-sheltered account, so perhaps there is a place for bonds over the long run ?!

  • 29 The Accumulator February 4, 2014, 6:59 pm

    @ Bluejm – The only real kink in your plan is that you’re overweighting the UK and correspondingly underweighting the US. As long as you’ve got good reason to do so then I don’t see anything here to worry about.

  • 30 Bluejeansman February 4, 2014, 11:49 pm

    @The Accumulator : Thanks for replying ! I am “overweighting” the UK because I live in the UK – I am based here – and I believe this is called “Home Country Bias” ? For example the average balanced pension fund (say for example Standard Life Pension Managed Fund) has 50% of its equities exposure to the UK.

    Even the Vanguard UK Lifestrategy funds had at least 33% of their equity exposure to the UK ( For some reason, this information seems to be no longer available).

    At my UK exposure = only 25% of my total equities, do you really think I am “overweighting” ?

    Also, I read somewhere that most of the FTSE100 companies already have Huge international exposure.

    You may ask why I still wish to keep money in the US given that I am based in UK. I dont want to go into that, as I will end up digressing.


  • 31 The Accumulator February 5, 2014, 10:29 pm

    You are overweighting because you’ve deviated from the rational, global portfolio – but that doesn’t mean you aren’t doing the right thing for you. I also overweight the UK, incidentally. Your point about the FTSE’s international outlook is well made, though some may argue it also overweights certain sectors e.g. energy.

    Here’s a link to a Vanguard paper on home bias. I’ve only had time to skim it so far, but it looks like interesting food for thought: https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/InvResHomeBias

  • 32 Nikhil Shah February 15, 2015, 7:09 pm

    Dear Accumulator,

    I am looking to invest my father’s pension mostly into the Vanguard LifeStrategy series.

    We have had various pension companies come home and give us model portfolios of investment trusts which are expensive ways of getting much the same exposures offered by the Life Strategy funds.

    We have generally been given allocations that look like: 60% equity; 20% bonds (15% UK; 5% intl); 10% hedge funds and 10% property by these advisors.

    The Lifestrategy fund gives us 80% equity (60% intl & 20% UK), 20% bonds (5% UK, 15% intl); Property 2%.

    Hence the vanguard portfolio is underweight in property and has no exposure to “diversifiers such as hedge funds.

    Given the international equity bias of the Vanguard portfolio, what diversifier assets, with likely low correlation to this portfolio would you recommend? Perhaps global, market neutral equity funds?

    I expect to put 80% of his pot into the 80/20 vanguard fund leaving 20% to put elsewhere.

    This will leave an overall allocation of 72% equities; 16% bonds and 12% elsewhere. Any ideas for “Elsewhere” asset classes or products?

    Any help much appreciated! Others please feel free to make suggestions too.


  • 33 Nikhil Shah February 17, 2015, 3:26 pm

    Hi All,

    No response on the above from anyone, so perhaps not a good question, or perhaps this question qualifies as seeking investment advice.

    I am now just trying to ascertain what the investment policy of the Vanguard Life Strategy series is beyond maintaining the stated equity / bond split.

    Does anyone know if country / underlying index (there are c.10 index products in each fund) are fixed? i.e. what the rebalancing rules are?

    I have checked, factsheet, KIID, prospectus etc but no luck.

    Any ideas?


  • 34 The Accumulator February 17, 2015, 8:50 pm

    Not a daft question at all. Just that responses on Monevator have to be worked in and around day-to-day lives. Now then…

    I just want to be sure that you know the LifeStrategy fund series can accommodate different equity:bond splits like 60:40, 40:60 etc. I guess you know this already but worth mentioning as the equity:bond decision is the most important asset allocation move you’ll make.

    The underlying indices and country allocations won’t be fixed as in set in stone, but they’re so broad you’d be hard-pressed to second guess them. For example, the Emerging Markets index might change weighting and countries within it may be promoted to the developed world (whilst developed world countries could fall the other way) but that’s essentially going to be a reflection of the fortunes of global capital.

    For a better answer, try mailing Vanguard direct. They’re normally responsive.

    A property fund is the most obvious diversifier. As is a greater allocation to index-linked gilts and short-term gilts – especially if your father is already retired.

    Commodities are another possibility but few commentators recommend them these days due to the difficulty of finding products that accurately reflect performance / are immune to the effects of front-running by predators / cope well with contango. There’s also lots of controversy over how often commodities actually perform and under what circumstances they assist a portfolio.

    Hedge funds have failed to hold up to scrutiny due to egregious charging structures that direct returns to fund managers rather than investors.

  • 35 The Investor February 17, 2015, 9:39 pm

    @Nikhil — Like The Accumulator’s reply, this isn’t personal advice, which we are not qualified to give (and even a professional advisor would need to know far more about your personal circumstances, which I implore you not to go into here 🙂 ) but I’d just add that you shouldn’t feel you need to match the complexity that was offered up to you by a hard-charging IFA in order to do well with passive investments. In my opinion their complicated portfolios are as much about confusing clients and justifying and extracting fees as about returns.

    As T.A. says, a few big decisions make the most difference. Check out the varying returns (or rather the lack of much variation) in this range of US “lazy” passive portfolios since the 1970s in the table in this post:


    A big benefit of a simple passive approach is… it’s simple. 🙂

  • 36 Nikhil Shah February 17, 2015, 10:26 pm

    Hi Accumulator,

    Thanks a lot for the above. Yes we are aware of the different equity bond split options.

    We were initially going for an 80/20 equity/debt split but reading your article, and looking at the performance of the MSCI ACWI over the last 15 years, we have decided to tone this down to 60/40; which is broadly in line with advisor designed portfolios for us.

    Vanguard have up to now not got back to me about index rules, as I think the question was too technical for the phone operator.

    However, I have found some detail on page 9 of the Target Allocation Approach document (https://www.vanguard.co.uk/documents/adv/literature/target-allocation-approach.pdf ) in case others are interested.

    Essentially, due to “home country bias” the UK is overweighted to 25% of the equity allocation compared to what is shown in the MSCI ACWI allocations above and the remaining 75% is allocated in some unspecified way.

    They provide information on this in the following prose:

    “Vanguard regularly reviews the asset allocation of LifeStrategyTM Funds, employing the most up-to-date research on portfolio construction, investor attitudes and always mindful of the lessons that long years of experience have taught us. Quantitative methods, such as optimisation, can help but do not exclusively determine the asset allocation of the funds. Instead, we use a number of inputs, which are aimed at meeting Vanguard’s principles for investing success.”

    Examining the most recent published allocations (for the 100% equity fund) we see the following: UK 25%, Europe 13%, North America 45%, Japan 7%, Emerging Mkts 7%.

    Comparing this to the ACWI weighting we can see that the UK at 25% is significantly higher (home country bias) and the others are lower as expected.

    However, allocations have not been reduced in proportion to market capitalisation. Thus leading me to suspect they are using a slightly more sophisticated allocation model, perhaps based on risk diversification principles, but so far I can find no way of knowing. The lengths one has to go to to get index construction information in this industry!

    However, I like the historical Sharpe ratio, and low performance fees, and the fact that we can avoid wealth manager fees due to the “All in One” structure, so we will still be going for it.

    I am tempted to introduce some Global Value and Global Small Cap bias through purchase of additional funds but I am not sure.

    Thanks for overview of potential diversifiers. UK gilts and property funds feature only very slightly in the LifeStrategy series so this is a definite option. If any specific funds / or just sectors with low correlation to ACWI please let me know.

    I read that “Frontier Markets” such as Nigeria etc have very low correlations (0.2) with ACWI so that could be another idea for a small slice of the portfolio as there is an S&P Frontier ETF, and we are a little bullish on these regions anyway.

    Other asset classes that I have read about are Private Equity – should you have any wisdom to impart on this then feel free.

    Thanks a lot – and sorry for the size of this post! Hopefully someone finds it interesting.


  • 37 The Accumulator February 19, 2015, 5:07 pm

    Thanks for the link. Very handy.

    Frontier markets – I’ve read that too. But when I chart the DB X-tracker Frontier Market ETF it seems to move in tandem with other equity markets – only worse. There isn’t really enough good data available to make a decision so I’ve left it alone.

    Re: hedge funds

    Re: private equity – watch out for Swedroe’s follow up article on that topic.

  • 38 Nikhil Shah February 23, 2015, 9:43 pm

    @Investor: Thanks so much for your reply. I didn’t see it before, and I appreciate the advice that complex IFA designed portfolios will likely not be optimal investment solutions.

    I looked at the interesting research provided on lazy portfolios, and it seems that the various asset allocation strategies do only perform within 200bps on an annual basis? Isn’t this quite a lot?

    More generally, I have a question here with regards to weighting schemes employed within the solutions you guys have researched. Am I correct in thinking that the underlying funds / indices used all employ capitalisation based weighting schemes?

    Have you guys researched building any lazy portfolios using alternative weighting schemes for each of the underlying indices? I think alternatively weighted (“Smart Beta”) funds are available for most markets however I wonder what the overall result might look like if using something as simple as equally weighted?

    Apologies if I have misunderstood the set up of your lazy portfolios.

    Thanks for the links re diversifiers swell – I will look out for Swedroe’s Private Equity article.


  • 39 The Accumulator February 23, 2015, 10:29 pm
  • 40 The Investor February 23, 2015, 10:39 pm

    @Nikhil — Yes, the returns do vary especially compounded over the long-term, but the takeaway for me is that over the short-term the results are similar (not just in terms of returns but also volatility and so forth).

    Unfortunately we can only know which will have done best in the long-term. The point being you could construct a very complicated portfolio now, put a lot of work into monitoring it, and do 150 basis points worse than if you’d just put the money into a 60/40 LifeStrategy fund and got on with life.

    I don’t think it’s a nihilist’s charter exactly (I’m obsessed with investing!) but I do think it’s a useful perspective.

    I see T.A. has responded to your other comments.

    The bottom line is it’s an exciting and interesting intellectual journey if you’re so inclined, but it’s a bit like philosophy in my view, as there’s not THE answer waiting at the end of it, just several answers, and more questions. (Apologies if that sounds cryptic, but I mean it quite deliberately).

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