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Early Retirement Extreme Forums » Money Questions

1. 

   joer1212
   

   Apprentice
   Joined: Mar '12
   Posts: 34

   Is this a good asset allocation for my employee Roth 401K and 457 plans?

   45% bond index fund

   20% large-cap index fund

   10% mid-cap index fund

   5% small-cap index fund

   20% international index fund

   I have about 8-10 years until retirement (I am 42, but want to retire early).
   I have low to moderate risk tolerance.
   I was thinking to increase the small-cap index fund to, maybe, 10% to make it worth the fees for this asset class (0.06%), but I would have to reduce something else, and I don't know what.
   The fees for my entire portfolio is 0.35%.
   I have two contradicting concerns. One is that my bond-heavy portfolio may suffer losses as interest rates rise, and bonds lose value.
   The second concern is that 8-10 years is not a long enough time line to load my portfolio with more stocks. I need some stability in my portfolio, as I will be quitting my job and counting on steady income.
   What should I do?

   Posted 1 year ago #
2. 

   secretwealth
   

   Expert
   Joined: Jun '11
   Posts: 1,517

   I'd suggest adding an allocation to a commodities fund. Since you have a low risk tolerance, maybe just 5%--still, I think it should be there, even if commodities tend to be volatile, I think they're a good inflation hedge.

   Posted 1 year ago #
3. 

   MattF
   

   Apprentice
   Joined: Aug '11
   Posts: 48

   A little bit of Real Estate wouldn't hurt either

   Posted 1 year ago #
4. 

   JohnnyH
   

   Expert
   Joined: Jul '10
   Posts: 1,366

   Seconding some commodity exposure... Also, might be a good time to have some cash on reserve. In 08 stocks lost 50% bonds rose 12%, cash was king.

   Posted 1 year ago #
5. 

   George the original one
   

   Expert
   Joined: Jul '10
   Posts: 1,943

   The interest rate risk you're taking on with that large bond fund allocation would encourage me to reduce it. MattF's suggestion of real estate is a solid choice.

   Posted 1 year ago #
6. 

   KevinW
   

   Master
   Joined: Aug '10
   Posts: 577

   IMO, if you're designing your own allocation, the two things you need to get right are 1) meaningful diversification across at least two assets classes, preferably more, and 2) actually following through on maintaining the allocation for the long haul. Simpler is better, and in general adding funds and/or weighting them arbitrarily makes follow-through more challenging. For that reason I prefer AAs using 2-3 funds that are "anchored" at 1/N or widely-used proportions, such as

   1/2 world stock index
   1/2 bond index

   1/4 total stock index
   1/4 total international index
   1/2 bond index

   1/3 total stock index
   1/3 total international index
   1/3 bond index

   60% total stock index
   40% bond index
   ("policy portfolio")

   If you want REIT and commodity you might do
   1/5 total stock index
   1/5 international stock index
   1/5 bond index
   1/5 REIT
   1/5 commodities

   which segues into my personal favorite, the permanent portfolio.

   Posted 1 year ago #
7. 

   jennypenny
   

   Expert
   Joined: Jul '11
   Posts: 1,344

   @KevinW--You don't list a % to keep in cash in any of the AAs you listed. Would you suggest just keeping whatever amount is needed for an emergency fund in cash with those AAs? I ask because with the PP you must have close to 25% in cash which is a lot more than a normal EF amount. Do you treat cash as an asset class? (meaning 80% stocks/20% cash would meet your criteria)

   Posted 1 year ago #
8. 

   KevinW
   

   Master
   Joined: Aug '10
   Posts: 577

   @jennypenny The OP seemed to be operating under the Boglehead/index-fund paradigm so I answered according to that doctrine. Their standard advice is to establish a cash emergency fund (EF) of 6-12 months' expenses and maintain that separately from portfolio assets. So cash is presumed to exist elsewhere and not listed as part of the portfolio.

   I always thought it was a strange non-orthogonality to measure cash in units of months and every other asset in units of percentages. IMO this part of the Boglehead system is incoherent.

   To answer your question, yes I think cash is an asset class. The PP is low-volatility so in an emergency you can liquidate part of the portfolio itself. You don't need to bother with an emergency fund "add-on." One of the strengths of conservative investing is that you can put all your capital into one self-consistent turnkey system, rather than tracking separate pieces with differing rules and internal accounting.

   Whether 25% cash is greater than 12 months' cash depends, of course, on the size of the portfolio vs. living expenses. For a conventional retiree with $1M portfolio and $40k expenses, 25% cash is a lot more. But for a starting investor with $10k portfolio and $20k expenses, 12 months is more. Also note that if you start from $0 and follow the advice to save 12 months' expenses before investing, you might be in 100% cash for years before you start buying securities.

   Posted 1 year ago #
9. 

   joer1212
   

   Apprentice
   Joined: Mar '12
   Posts: 34

   Thanks for the suggestions, however some of the funds you recommend are not offered at my job (I work for the MTA, NYC Transit).
   I wish they had a "total stock" portfolio, because if they did, I would definitely simplify things and invest only in this, instead of three funds.
   I would also probably add REIT's and commodities if they were offered, which they are not; not to mention that I would also purchase a few individual dividend-paying growth stocks, if only they had them.
   The only investment choices I have are:

   * actively-managed mutual funds (individual, and Target-Date Funds)

   * index funds

   * a "stable" fund

   That's it.
   I didn't choose any of the actively-managed funds because the fees are too high. The stable fund yields too little, so the only logical choice was low-cost index funds.
   I came up with my asset allocation by trying to copy the Target Date funds.
   I examined the asset allocation of the "2020 Target Date Fund", and tried as closely as possible to match that allocation on my own, without the management fees.
   Actually, the 2020 Target Date Fund invests 52% of the portfolio in bonds, TIPS, and the Stable Fund. I thought that was a little TOO conservative, so I increased my stock exposure a bit.
   If we were living in a more typical investment climate, I would go with conventional wisdom and keep my portfolio as it is (45% bonds/ 55% stocks). The only reason I am questioning this is not because I think this is a bad ratio, but because interest rates are at an all-time low, and can only go up from here. When they inevitably do, 45% of my portfolio (which I plan to retire on in about 8 years) may take a massive hit.
   Similarly, if I increase my stock exposure, volatility can derail my retirement plans.

   Posted 1 year ago #

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