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Asset Allocation in 30 Mins a Year

If you don't have any interest in spending the rest of your life following stock tickers and listening to analyst conference calls, the following approach can be implemented extremely easily, is very cost effective, and should take less than 30 minutes each year to maintain.

This approach is suitable for people who a) have saved at least $5,000 and b) are aged 10-60. If you are older than 60 you should probably adopt a more conservative approach or allocate the stock portion of your portfolio to conservative stocks. If you have less than $5,000 you should spread your investments over fewer funds otherwise trading fees will dampen your returns considerably.

At the top level, you allocate your investments as follows:

1. 60% stocks
2. 20% real estate
3. 10% bonds
4. 10% commodities

There's no real magic to this. It just depends on how much risk you want in your portfolio. If you already own a house, we recommend halving or eliminating the real estate section and increasing the rest. Then break down the stock allocation as follows:

1. 60% US stocks
2. 40% International stocks

That is a good mix given the increased participation in the global economy of countries outside the US and helps guard against currency fluctuations of the dollar.The US stocks we recommend breaking down as follows:

1. 33% Large cap stocks
2. 33% Medium cap stocks
3. 33% Small cap stocks

The international equity allocation can be split between the emerging economies and the developed world:

1. 50% Emerging markets (South Africa, China, India, Brazil, Russia etc.)
2. 50% Developed markets (Europe, Japan, etc.)

For the bond allocation, we recommend a broad-based bond index fund (a mix of long-term and short-term bonds). For real estate you can only really invest in commercial real estate (office buildings, shopping centers, apartment complexes). You then round out your portfolio with an allocation to commodities: oil, precious metals, agricultural products etc. Putting that all together works out to the following target portfolio (with ticker symbols and fees of representative index funds in brackets):

1. 12% Large cap US stocks [ VV, 0.07% ]
2. 12% Medium cap US stocks [ VO, 0.13% ]
3. 12% Small cap US stocks [ VB, 0.10% ]
4. 12% International : Emerging market stocks [ VWO, 0.25% ]
5. 12% International : Developed markets stocks [ EFA, 0.35% ]
6. 20% Commercial real estate [ VNQ, 0.12% ]
7. 10% Bonds [ AGG or VBMFX, 0.20% ]
8. 10% Commodities [ IGE, 0.48% ]

It should be possible to create a portfolio with a blended fee of 0.14% or less. The table below shows the correlation between the various assets in this portfolio over the past 365 days:

This portfolio has an intra-portfolio diversification of 0.52

The standard deviation for each asset is a measure of the degree of risk of that asset. The higher the standard deviation, the more risky the stock, fund or bond.

Always try to find the funds with the lowest fees. High management fees are a vastly underestimated destroyer of long term wealth. You will always pay higher fees for international stocks and the more esoteric funds. You should definitely never pay more than 0.50% in annual fees. The highest fees are for emerging markets funds and specialty funds which should be around 0.45%. The lowest cost funds, like standard S&P 500 index funds, have fees below 0.1%. Fees tend to come down in the long run so keep reevaluating your choices.

One slightly tricky part is balancing your asset allocation across your retirement/non-retirement/tax-deferred accounts. Thanks to the complexities of the US tax code there is no way around having three or four investment accounts. A good rule of thumb is to have the investments which pay dividends in the tax-sheltered accounts and the high-risk, high growth assets in the taxable accounts.

Finally, once you have got your asset allocation set up, you need to rebalance it once a year. Since the various funds grow at different rates, eventually your carefully assigned percentages will be off target. One solution is to add your latest contributions to whichever fund is the furthest off at the time. That way you end up investing new money in the funds which have performed poorly recently (buying low). At the beginning of each year, you can spend 30 minutes rebalancing your portfolio to make sure you remain on target.