Your Asset Allocation Is the Most Important Aspect of Your Portfolio

Barbara Friedberg has been running a 5-part series on asset classes investing on her personal finance blog. In Part 3, “What is Risk Tolerance and How to Figure Out my Asset Classes Allocation,” Barbara gives some good thoughts on asset allocation. People with a high risk tolerance should hold more stocks, for possibly greater return, and people with a low risk tolerance should hold more bonds, so they will not lose as much in a large market downturn (they also will not make as much in a bull market, but that is the tradeoff).

3-fundI am highlighting Barbara’s post, because your asset allocation is one of the most important parts of setting up your portfolio. Here are some thoughts on asset allocation from some of the most renowned people in economics,

John Bogle, author of Common Sense on Mutual Funds: “Asset allocation is critically important; but cost is critically important, too—All other factors pale into insignificance.”

Frank Armstrong, CFP, AIF, and author of The Informed Investor: “The impact of asset allocation or investment policy swamps the other (investment) decisions.”

Jonathan Clements, author of three financial books, Funding Your Future; Twenty-Five Myths You’ve Got to Avoid; and You’ve Lost it, Now What? “Forget Wall Street’s exotic garbage. Instead, stick with stock, bond, and money market funds.”

Walter Good, CFA, and Roy Hermansen, CFA, co-authors of Index Your Way to Investment Success: “Development of a long-term investment plan constitutes the most important single investment decision that you are likely to make.”

Professor Burton Malkiel of Princeton University, author of Random Walk Down Wall Street: “The most important decision you will probably ever make concerns the balancing of asset categories (stocks, bonds, real estate, money market securities, etc.) at different stages of your life.”

John Merrill, author of Outperforming the Market: “Your portfolio mix of asset classes will be far more important in determining its performance than will be your selection of individual securities or mutual funds.”

Jane Bryant Quinn, author of Making the Most of Your Money: “People don’t pay a lot of attention to asset allocation, but it’s the key decision that determines your investment success, not how smart (or dumb) you are at picking stocks or mutual funds.”

Bill Schultheis, author of The Coffeehouse Investor: “The most important factor when diversifying is to adhere to your asset allocation strategy, because when you stick to your strategy and rebalance your assets at year-end, buy and sell decisions are no longer arbitrary.”

Charles Schwab, founder of the Charles Schwab brokerage company, and author of Charles Schwab’s Guide to Financial Independence: “Choose your asset allocation model carefully. Asset allocation is the biggest factor in determining your overall return.”

Vanguard has an asset allocation questionnaire that may help you to define your asset allocation.

They also provide a table of portfolio allocation models ranging from 100% bonds with zero stocks, to 100% stocks and zero bonds, that provides some good statistics on the average earning potential, as well as largest annual gains and losses for various asset allocations.


14 thoughts on “Your Asset Allocation Is the Most Important Aspect of Your Portfolio

  1. Rebalancing and asset allocation is probably something I don’t look at enough, because it never really seems as important as it actually is for some reason… but as all of those quotes say, it certainly is vital to maintaining a healthy portfolio!

    1. Hi JR, Thanks for your comment. As I said in the post, asset allocation across your whole portfolio is critical. Rebalancing, though, is not as critical. It should only be done once, or perhaps twice a year. John Bogle has stated, “If you can ignore market fluctuations along the way, it’s better not to rebalance, since you’re likely to get higher returns.” He compared the performance of a 70% stock/30% bond portfolio that was rebalanced annually with one that was never touched. Over 187 25-year periods ending between 1826 and 2012, the rebalanced portfolio earned a sliver less on average. In 55% of the periods, rebalancing beat doing nothing, by an annualized 0.23%, adjusted for inflation. When rebalancing hurt returns, the penalty was a larger -0.43%.

    1. Hi Charles, Thanks for your comment. I enter all of my account holdings into Morningstar’s Portfolio X-Ray tool. It quickly breaks out assets in terms of equities and fixed income (bonds and cash). You can use it free at T. Rowe Price You have to register for a free account to use it. I don’t know anyone who includes real estate in their asset allocation calculations, but my wife and I only own the house we live in, so I haven’t really considered it. I have read that some people view equity like a bond and a mortgage loan as a reverse bond. REITs in the form of mutual funds or ETFs should definitely be counted as part of your asset allocation. Most people treat them like dividend paying equities. Their dividends are mostly not qualified for lower taxation, however, so they are taxed as ordinary income at your highest marginal rate. Thus, you should hold REITs (and MLPs) in a tax sheltered account, like an IRA.

  2. If we are to take it from the experts, there is really a good reason behind allocating assets properly. Is it something similar to the wise saying that you should not put all your eggs in one basket?

    1. Hi Jen, That is a lot of it. Some is to also try to get those baskets uncorrelated. Often when equities go down, bonds go up, and vice versa. It used to be that foreign equities were not always correlated with US equities, although it seems that they are becoming more correlated as industries become more international. Looking for non-correlated equities, REITs often have the volatility of stocks, but they are often more correlated with movement in bonds. Asset allocation tends to smooth the volatility of equities. Everyone needs to find the asset allocation that will mainly protect them in the event of a market downturn. Finally, as you get older, you don’t have the time to make up lost assets, so you should protect them by balancing into less volatile holdings like bonds, CDs, and savings accounts.

    1. Hi Daisy, As I responded to JR, rebalancing is not as critical as getting your initial asset allocation right, and then adjusting it as you age. There are problems with rebalancing too often which is akin to momentum trading. Most people say you should look at your asset allocation and rebalance once a year, although John Bogle says even that may be too often. He says the most critical things are adjusting your asset allocation as you age to reduce volatility, keep expenses low, and be tax aware.

    1. Hi Stephanie, Vanguard’s Target Date funds are great for people who don’t like to hassle with rebalancing. And Vanguard is the least expensive of all. I wrote a post awhile ago describing a few problems with target date funds. One is that they are often more expensive than if you owned their constituent funds. Another is that some have high-cost active funds in them. And finally, is that they may be more agressive in their asset balance than most people realize. I would not buy a target fund based on its target date, but would look at its fund holdings to make sure it matches the asset allocation that I want for my age.

      Overall, though, I very much like Vanguard’s target date funds for people who don’t want to bother rebalancing. If you look at my post on target date funds, you will see the glidepath that the Vanguard funds use as well as the very diversified funds that they contain.

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