Diversification & Asset Allocation

[Kevin20]

Occurs to me I'm always preaching asset allocation and diversification here. So I'll show what I do in my own 401k and open myself to insults and questions.

 

I have a pretty limited range of choices -- 15 funds from various fund families. They are all C shares, meaning they are not no-load funds, but instead carry a load in the form of a 1.0% annual 12b-1 fee, forever (as opposed to a typical 0.25% fee or less). This is not great for the investor, because it means each fund has an expense ratio usually above 2% a year. Kind of a bum deal, but I don't have a choice.

 

So with my choices I want an allocation that gets me participating in several diverse asset classes. Various of my15 funds pretty much fall into these asset classes:

 

Large Cap U.S. Stocks

Small Cap US Stocks

US REITs (commercial real estate companies)

Bonds (Gov't & Corporate)

Foreign ("International") Stocks

Money market

 

So I want to do 2 things: a) first decide on allocation percentages -- what my pie chart looks like, and b] Which fund is best to represent each slice of the pie. I expect to work another 20 - 25 years, so I want good exposure to risky assets.

 

So here's what I've settled on.

 

30% Large Cap U.S. Stocks -- Davis New York Venture C

20% Small Cap US Stocks -- Oppenheimer Main Street Small Cap C

20% US REITs -- Aim Real Estate C

10% Bonds -- Loomis Sayles Investment Grade Bond C

20% Foreign Stocks -- Alliance Bernstein International Value C

 

 

My allocation percentages are a naive approach, with those nice fat round numbers. You could use fancy software to analyze investment choices, past performance, and your risk tolerance to find a point on the "efficient frontier" -- which seeks an optimal balance of expected return with risk ... and wind up with allocations like 16.6% and 23.4%.

 

But an efficient frontier analysis is backward-looking and cannot predict the future anyway -- its Achilles heel. My approach is probably just as good and a lot simpler.

 

And about every 6 months, as the pie chart gets distorted from the varying rates of return among the funds, I REALLOCATE back to my planned allocation. This means shift money from the winners into the losers -- that's the discipline.

 

As for performance -- I don't really care about the short term ... I've got a 20+ year horizon. But, my 401k plan lets me click a button online and see that my portfolio's rate of return is at an annualized 1% year to date, and better yet an annualized 7% for the last quarter (that's actual return, not the result of new contributions). Compared with the US stock market S&P 500 being down nearly -15% year to date, I'm pretty happy, and that makes me pretty resistant to the gloom and doom I keep hearing.

 

Bets performers since my last reallocation are the Small Cap fund and the Real Estate fund. I could not have predicted that, but I'm glad I included them in my allocation.