Deciding upon your asset allocation can be as simple or as complicated as you wish to make it. You might watch a couple of TikTok videos and decide to go all-in on Griftcoin. Or spend the rest of your life drawing Bollinger bands on charts of obscure Japanese small caps.
A much better alternative is to:
- Learn the basic tenets of strategic asset allocation– that is, what blend of asset classes suits your circumstances and in what proportion?
- Understand what each of the main asset classes is for – how it behaves, the threats it combats, plus the risks and trade-offs you accept by holding it.
- Gain exposure via low-cost index trackers that deliver the performance of each asset class as faithfully as possible.
- Set-and-forget your portfolio, because it’s designed to cope with all investing weathers: rain, shine, inflation, deflation, stagflation, market crashes, and bursting bubbles.
In this post I’ll run you through a simple method to create a robust asset allocation. We’ll consider what questions 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
The first thing to understand is that there isn’t an optimal asset allocation.
Nobody knows in advance what the best performing assets will be over the next five, ten, or however many years.
That’s why the one consistent piece of advice you will hear is: Diversify.
Plenty of commentators make predictions. Forecasts are catnip for humans after all. Moreover, no one is ever seriously taken to task later for the accuracy of their calls. But it’s still notable that financial prognostications are bedecked with the kind of get-out clauses that would make a fortune-teller cover their face.
Forget the prediction game. It makes fools of us all.
In contrast, adopting a strategic asset allocation positions you for long-term success while offering protection against the many dangers that assail investors.
It’s all pros and cons
The second thing to know is that every asset class has its strengths and weaknesses.
Equities (also called stocks) are violently unpredictable, while nominal government bonds and cash are vulnerable to inflation.
Nothing is inherently ‘safe’.
However the mainstream assets we cover in this article can all play a role in a diversified portfolio.
Your task is to decide which mix is most likely to serve your personal goals.
Who’s portfolio is it, anyway?
Finally, it’s worth thinking hard about your particular objectives and risk profile.
Loud and influential figures on the Internet will speak of the astounding opportunities in Strategy X and the obvious inefficiencies of Strategy Y. But these confident voices rarely consider your age, financial situation, knowledge level, time constraints, or your baseline interest in the markets.
What’s sauce for them may be poison for you.
Compare a 60-something multi-millionaire retiree to a 20-something who’s scraping together £50 for their first ISA investment. These two are almost certainly not playing the same game nor speaking the same investment language.
So be careful who you listen to. Ask where they’re coming from.
Asset class action
To better understand which asset classes deserve a starring role in your portfolio it’s worth sketching out your plan in broad outline.
Think about:
- Investment goals – what’s the money for? Financial independence at 50? Retirement at 65? The rainiest of rainy days?
- How much do you need?
- In how many years will you need it?
- How much can you invest towards your goal?
- What expected return might your portfolio produce?
An investment calculator can help you work out if your numbers add up.
The physics of investing mean that:
The amount you save…
Multiplied by your average investment return…
Over the years you invest…
Determines your future wealth.
If that amount falls short of your target number then you can decide to save more. Or invest for longer. Or to try to live on less.
By way of returns
Note though that your average investment return lies largely outside of your hands – which is something that many people find hard to accept.
Your portfolio’s expected return can stand in for your actual investment return when you first boot up your plan.
But your actual number achieved depends on unknowable future investment results.
You might attempt to nudge up the returns you achieve by increasing your allocation to a high-growth asset like equities.
But this is a risky move. Banking too much on such a volatile asset also increases the chance you’ll undershoot your target if stocks fail to deliver according to your timetable.
Fate is fickle.
Getting going
Alright, that’s enough planning background for now.
Don’t worry if your numbers are a little hazy. Think of investing as like piloting an old sailing ship in the days before GPS.
You just need a rough idea of where the land lies to begin with. You can always make further course corrections along the way.
Keeping it simple
The minimalist’s approach to portfolio diversification splits your money between equities and government bonds.
These two assets are a time-tested and complementary combo.
Equities are powerful like a rocket engine. When firing beautifully, they can shoot your wealth into the stratosphere. But this engine is prone to stalling. Occasionally equities will send your portfolio into a gut-wrenching free fall.
That’s why it’s wise to invest in government bonds, too. Firstly as an alternative (but lesser) source of thrust. Secondly because bonds often work when equities fail. This ‘flight-to-quality’ effect means bonds can cushion your portfolio during a stock market crash.
Historically, equities have outperformed all other mainstream asset classes – on average, if you can wait long enough for the market to come good.
And this tempts some people to go for glory with 100% stock portfolios.
But sometimes equities do suffer long losing streaks. You could spend a decade or more going nowhere.
That’s fine if you patiently keep buying shares on the cheap. History tells us they will rise again.
But problems rear when you can’t wait – because you’re a forced seller, or because you’re impatient, or because you panic when stocks bomb.
It’s easy to be swayed by the high average returns of equities. But you will rarely experience the average return.
Equities can be dreadful for years. Or they can be amazing for years, then suffer a terrible rout that wipes out all your progress.
Most likely, you’ll endure a wild ride that periodically flips from good to downright scary.
You probably shouldn’t give it 100%
These psychological switch backs are why people are generally ill-advised to go 100% equities.
Traditionally, such a high level of risk is more readily borne by:
- Beings with an emotional temperature near Absolute Zero.
- Someone who isn’t relying on the money.
- Investors who can easily repair the damage – typically because they are young and so have committed a negligible amount of their lifetime savings to the market so far.
In reality, few of us can happily stomach watching our wealth drop 50% to 90%. Many people don’t realise how awful it feels until it’s too late.
Hence, the trickiest part of asset allocation is understanding how much equity risk you can personally take.
Your place on the risk tolerance spectrum is impossible to know with any confidence until you’ve received your first shoeing in the market.
The finance industry uses risk profiling tests in an attempt to understand how you might react before then.
But we’ll offer an even cruder approach below.
Choosing your equities
Despite all the risks, most people must invest some of their portfolio in equities. That’s because their goals require a long-term rate of growth that they’re unlikely to get from bonds, cash, or the other asset classes.
Stocks’ inherent riskiness can be somewhat tempered by investing in the broadest pools of shares possible.
Spreading your money this way enables you to avoid taking concentrated bets on individual companies, industries, or regions that could hit the skids.
Global tracker funds enable passive investors to diversify away such idiosyncratic risks at a stroke. Moreover they enable you to invest in every important stock market in the world at the tap of a button for minimal cost.
Critically, the allocations of global index trackers are driven by the aggregate buy and sell decisions of every investor operating in these markets.
You’re harnessing the wisdom of the crowd when you invest this way.
Bring on the bonds
The point of bonds is to dilute the riskiness of equities. Hence we usually want to pair our shares with the least volatile bonds around:
- High-quality government bonds – ideally nominal short to intermediate durations, and/or short duration index-linked.
- From your home country – so gilts for UK investors. Or else global government bonds hedged to GBP.
- You can use individual bonds or bond funds.
What percentage of your portfolio should be devoted to bonds? Again, there’s no ‘correct’ answer. It depends on your personality, goals, and financial situation.
However 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. Whereas if you happen to own an orchard of money trees and wade through fallen bank notes like autumnal leaves then you won’t have to bother with all that nasty bear market business.
In such a scenario where you don’t need much growth – say just 0.5% to 1% real return per year over the next ten years – you can hugely reduce your reliance on equities.
In other words, if you’re more interested in capital preservation, then a bigger allocation to shorter-dated conventional government bonds and index-linked gilts makes sense.
Associated rule of thumb: 120 minus your age = your allocation to equities.
In particular if you need the money soon then equities are a big risk.
And by ‘soon’ I mean anytime in the next ten years.
Rushing roulette
Equities have a one-in-four chance of returning a loss inside any five-year period and a one-in-six chance of handing you a loss within a given ten years, according to Tim Hale in his superb book Smarter Investing.
So do not allocate anything like 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. Put the rest of the portfolio in bonds.
If your target is flexible, or you can delay your plans, or the stock market money is a bonus in the big scheme of things for you, then you can increase the risk you take accordingly.
For example, if your retirement living expenses are amply covered by income streams such as a workplace pension and the State Pension then you could up your equity allocation in your ISAs, say.
If equities plunge in value then no matter. You can ride out the dip and enjoy the upside whenever a recovery comes.
That said, your risk tolerance is the house that rules all.
Risky business
The nightmare scenario with any asset allocation is that it’s too risky for you.
If you panic and sell when markets plunge you’ll lock in losses and permanently curtail your future returns.
Even young investors can be psychologically scarred by early losses that put them off investing for life.
But how do you know your risk tolerance until you’ve experienced a serious setback?
One solution for new investors is to dip only a cautious toe into the market to start with. For example, you could opt for a 50:50 equity-bond split until you’re tested by your first market crash.
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 ten 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
| 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 |
Bear in mind that your risk tolerance is a moving target. It’s known to weaken with age and as the amount at stake rises. Therefore even a seasoned investor should reassess their allocation from time to time and consider lifestyling to a lower equity allocation as they age.
Finally, remember that the rules of thumb aren’t scientifically calibrated. They’re quick and dirty shortcuts based upon the practical wisdom gathered by previous generations of financial practitioners and investors.
Hopefully they can guide you to the right destination at a relatively safe speed. But sadly there are no guarantees.
Here’s a final rule of thumb: a 60:40 equities and bonds split. This has become the industry standard for the ‘don’t know’ or ‘Joe Average’ investor.
Press play to continue
Once you’ve thought through your equity/bond division, 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 and even outsource the fine details to 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.
Inflation defence
Equities, government bonds, and cash will take you a long way. But they do leave a chink in your armour.
All three assets typically flounder during long and hairy surges in inflation.
This doesn’t matter so much for young investors, who can rely on positive long-term growth rates from their shares to outstrip inflation eventually.
But retirees living off their portfolio should think about incorporating an inflation-resistant asset that they can sell as needed if consumer prices spiral.
Short-term, index-linked, government bond funds are likely to perform better than other bond funds in these circumstances. However, rapid interest rate rises proved an Achilles heel for these assets post-Covid.
Individual index-linked gilts (affectionately known as ‘linkers’) are a better match for fast-rising prices.
Linkers seem complicated at first, but mostly that’s because they’re unfamiliar rather than intrinsically complex.
If you’re an older investor who’s prepared to devote some time to learning about them then I think index-linked gilts are worth the effort.
Commodities also thrive during at least some inflationary episodes. And they can be bought off the shelf using diversified commodity ETFs.
Commodities also require a slog up a learning curve. You especially need to consider how extremely volatile commodities can be.
Still, the asset class’s long-term returns look reasonable – sitting between equities and bonds. We’ve put a 10% slug of commodities into our model retirement portfolio.
Gold is the final mainstream asset that periodically performs well against high inflation.
The yellow metal isn’t specifically designed to counter inflation like index-linked gilts are. Nor does gold have a reassuringly long track record of outstripping inflation like commodities.
But gold has worked during two of the last three price shocks.
Although gold’s recent performance makes it look like a no-brainer, the story is more nuanced over longer periods. Do make sure you understand the pros and cons of gold before making an allocation.
Further asset allocation ideas
There are plenty of other asset classes you could consider. We can debate them in the comments.
But the selection above covers the crucial assets. By themselves, they are enough to hit your goals and muster a porcupine defence against any of the major economic threats you’re likely to face.
One thing I haven’t mentioned is that many people have substituted money market funds for bonds since the latter crashed in 2022.
However, there are four reasons not to do this:
- The long-term returns of nominal government bonds are significantly higher than money market funds.
- Nominal government bonds are more likely to reduce stock market losses during a crash.
- Similarly, nominal govies are the place to be if deflation sets in.
- Lastly, government bonds are far better priced now than they were in 2022.
Reasons two and three also explain why you’d hold a nominal government bond allocation that’s separate from a slug of index-linked bonds.
How much?
Know that 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.
Most people should avoid adding so many sub-asset classes that you end up with a raft of sub-5% allocations.
These add unnecessary complexity for negligible gain.
Model behaviour
Okay, I know that’s a lot to take in. No wonder many investors turn to model portfolios to help firm up their ideas.
Some ready-to-share asset allocations we’ve written up include:
- Investment portfolio examples from the investing greats (and us…)
- Our own Slow & Steady model portfolio
- The All-Weather portfolio – especially well-suited to older investors
- Our decumulation portfolio
However you go, you’ll find there’s a good range of low-cost index trackers to cover almost all the asset classes you might include in your portfolio.
Take it steady,
The Accumulator
Note: we updated a decade-old article on asset allocation to create this post, so early comments below may refer to this previous incarnation. We like to keep our old discussions for posterity, but please do check the dates with anything time sensitive.
great summary. Second the request for some more reviews of all-in-one fund or ETF options (if they exist beyond Vanguard Lifestrategy!)
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……….
1908-1912
There were five consecutive years that produced a 10-year loss all of which periods included World War 1.
1964-1972
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.
1999-2000
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.
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.
@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
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….
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.
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.
@ 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.
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 ..
@PC
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
Great article. One of the best summaries of Asset Allocation I have read. Thank you.
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
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.
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?
@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).
I found this document outlining the rationale for the previous asset allocation:
https://www.vanguard.co.uk/documents/adv/literature/target-allocation-appproach.pdf
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….
@ 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!):
http://monevator.com/buy-shares-in-retirement/
http://monevator.com/asset-allocation-strategy-rules-of-thumb/
@ 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!
@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%
There’s a little info on LifeStrategy asset allocation changes here:
https://www.vanguard.co.uk/adviser/adv/articles/vanguard-news/new-enhanced-lifestrategy-funds.jsp
A really interesting article, and one I wish I had 3 years ago when I started my investing journey.
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.
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?
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.
@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”. 🙂
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
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 !
@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 ) :
http://www.norstad.org/finance/total.html
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 ?!
@ 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.
@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.
Thanks.
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
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.
Best,
Nikhil
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?
Nikhil
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.
@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:
http://monevator.com/weekend-reading-return-and-volatility-data-for-the-us-lazy-portfolios/
A big benefit of a simple passive approach is… it’s simple. 🙂
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.
Best,
Nikhil
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
http://www.etf.com/sections/index-investor-corner/swedroe-be-leery-hedge-funds
Re: private equity – watch out for Swedroe’s follow up article on that topic.
@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.
Nikhil
Hi Nikhil,
Here’s the private equity link:
http://www.etf.com/sections/index-investor-corner/swedroe-debunking-private-equity’s-myth
Some thoughts on a risk factor / alt weight portfolio:
http://monevator.com/how-to-build-a-risk-factor-portfolio/
Some thoughts on why it might not work / make much difference:
http://monevator.com/why-return-premiums-disappoint/
http://monevator.com/why-market-cap-investing-still-works/
@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).
So after a period of procrastination, I’m once again looking for an alternative to my VG LS80% fund (to somewhat diversify away from Vanguard), and have landed back at this article (5 years on!).
Given that the reviews from MV in the past didn’t look too highly on the alternative all-in-one funds, it looks like I *may* need to pick funds myself.
Assuming I want to keep the same 80%/20% allocation, would the following seem a reasonable/sensible starting point (before I head over to pick specific funds)?
– 70% World Equities (inc UK/Emerging Markets)
– 10% Global property (for a little more diversification, away from equities)
– 10% UK Government bonds – short (0-5yr)
– 10% UK Government bonds – index-linked
Just a quick point (and an attached long article) on fixed income.
Global fixed income, if hedged, appears to give better return and risk reduction than home bias. https://www.vanguard.co.uk/documents/adv/literature/going-global-with-bonds-tlor.pdf
There is a modern view that investing in bonds does not provide any safety anylonger. The reason given for a such is the QE across the world and consequent low interest rates.
What is the evidence on how bonds behave under such a scenario and consequent ‘return to normal’?
Well, I can tell you that my bond allocation has done exactly what it is there for – it reduces portfolio volatility. My bond funds tend to lose a little bit when equities are roaring ahead, but in dips, like the last 10 days, they have risen a little.
I’m always perplexed by how hung up on bond ‘risks’ people are, whilst happily being exposed to far riskier equities…
Hi Yuriy, 100% agree with Vanguardfan. Most dips I’ve experienced, conventional government bonds hold the line, including right now. I haven’t come across credible evidence that they are no longer capable of performing this role, albeit there’s less scope to be cushioned by high yields or by capital gains given the fall in interest rates over the last 12 years. Diminished capability doesn’t mean no capability. Consider high US equity valuations do not spell the end of future gains by US equities – another discussion point of the last decade. Check out this piece on the performance of bonds, cash and gold in a crisis:
https://monevator.com/how-to-protect-your-portfolio-in-a-crisis/
Hi everyone,
This site has such a fantastic resource but I am still a little confused as to how I should best set up a bond allocation. I am very new to the game. I currently reside in Hong Kong but am from England and likely to settle in England at some point.
I am 28, so quite young in my investment lifetime and so feel ready to take risk for long term reward.
My current plan is
80% (or 85%) Equity
20% (or 15%) Bond
Equity: VWRL (80/85%
Bond: VAGP (Global AGGREG BOND) or/and VGOV. (U.K. Gilt UCITS ETF) (20/15%)
Would this Bond allocation do well to protect me in volatile markets? Do I need both bonds?
Hi Milo,
80:20 equity:bonds won’t cushion you much against volatility. It’s the bare minimum diversification you should have, but if you don’t know how you will react in a crisis it could be a good idea to be more conservative to begin with. This piece may help:
https://monevator.com/how-to-estimate-your-risk-tolerance/
For a taste of how different allocations perform, you could take a look at the losses taken during the recent crisis by the Vanguard LifeStrategy 100, 80, 60 and 40 funds. Plot them against each other using Trustnet’s multi-chart tool.
You don’t need both bond funds. They fulfil the same strategic function. VGOV has a longer duration than VGAP. It’s likely to outperform VGAP if government bonds do well in a crisis but may also take a bigger hit initially if interest rates rise. For my money VGOV is the better complement to VWRL but you could argue it either way. I wouldn’t worry too much about it either way while you’re getting started and there’s lots of bond articles on Monevator that’ll help you get a feel for the debate.
@ Yuriy – I had your comment in mind when I wrote this:
https://monevator.com/negative-yields-bonds/
There’s a follow up post to come about how prices will respond if rates fall further. Bottom line is intermediate government bonds and long bonds have still plenty of potential to perform well if interest rates fall further. There’s no reason to think interest rates can’t fall further. Long bonds though are particularly vulnerable to loss if interest rates rise again.
I know this is an old article but how can the period 1999 – 2000 include the 2008 financial crisis, or am I reading it wrong?
1999-2000
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.
Thank you for the article.
I am in the decumulation phase, except I haven’t really decumulated anything yet, but am about to start.
Don’t need growth other than to compensate for inflation.
120 minus my age gives about 50% equities which seems high to me and if I was 90 not sure what purpose 30% equities would serve.
Still, as you say, there is not really a right answer.
I’m sure this is blindingly obvious to most readers but, within the diversification mix, the article suggests considering nominal bonds and gilts.
What’s the difference?
Interesting reading back through they years on the bonds front. So here’s a question, I’m down about a third on VGOV and IGLT. Is there any way I’m going to recoup those losses? I think the answer is no.