My New Asset Allocation (Part XIV)

by Mike Holman

Yes, that’s right – after reading countless books and posts about asset allocation and writing several convoluted and contradictory posts on the topic myself, I’ve finally decided on an asset allocation model for our investments. The problem with asset allocation is that there is a lot of theory behind various models and the more you know about the subject then the more confused you will probably get. I’ve concluded recently that maybe just picking a simpler asset allocation is probably the best approach since I’m not sure how much it really matters what your exact asset allocation is, as long as you pick one and stick with it.

And now (drum roll please..) on with the allocation!

Equities vs Bonds

The split will be 75% equities and 25% bonds. I like to have a fairly aggressive portfolio but at the same time the bonds will steady the returns and will also allow for more equity purchases in case the equity markets go off a cliff. According to Mr. Bernstein, 75% equity gives you the maximum benefit from owning equities.

Equities 75%

These percentages are of the equity portion (not percentage of the total portfolio).

Canadian equity – 25%

US equity – 37.5%

International equity – 37.5%

Bonds – 25%

20% is a short term Canadian bond ETF (iShares XSB) and some GICs.

5% is a real return bond ETF (iShares XRB). Real return bonds are a hedge against inflation and are supposed to be negatively correlated with regular bonds.

Other asset classes?

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What about real estate and emerging markets? I’ve decided not to invest in those right now because both of these classes have done so well in the past several years that it’s hard for me to justify buying them. I’m also not convinced that emerging markets are all that great an investment. When you consider the exposure that a lot of North American companies have to developing markets, I already have enough emerging market in my portfolio.

Anybody want to share their asset allocation philosophies?

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{ 34 comments… read them below or add one }

1 Mr. Cheap

Keeping it simple seems like a good plan to me. Are you holding the bonds inside your RRSP?

At what point will you integrate emerging markets and real estate into your allocation? What signs will you look for before you say “nows the time to buy”?

What does your breakdown of US equities look like? Telly (and Bernstein) seem to like small caps, which has me looking at the Russel 2000 a bit…

2 The Financial Blogger

I like the way you split your portfolio. Maybe you could just use 5% of the international portion and invest into emerging markets. It would not add too much to your market’s volatility.

I don’t like bonds too much but I guess that 25% is not that bad when you have enough money to invest.

For the rest of your portfolio, do you think investing in stocks or in mutual funds?

3 Traciatim

That’s very similar to my RRSP allocation, only without the bonds. The company I work for only has 5 funds available; bonds, money market, balanced, Canadian Equity, and lobal Equity.

Since they match 100% of 6% of my salary I just use their match, I figure I’m up 100% already why not go risky. So I have min split about 70/30 in the global equity (which is about 40% the USA) and Canadian Equity.

This may abe a little aggressive, and I probably should switch my RRSP so any interest income goes in there and invest outside for dividend returns, but so far I’m just pretty passive about it all.

4 Four Pillars

Mr. C – bonds (and pretty much everything else) is in the rrsp.

I don’t know when I’ll buy EM and RE – not buying them is a form of active management which goes against Bernstein et al but part of the reason is simplification.

The US equities is all VTI – US Total market ETF. That includes small caps in their market share.

Mike

5 Four Pillars

FB – You’re not wrong – eventually we’ll get some EM. Most of the portfolio is ETFs with some mutual funds. The only individual stocks I own is BMO.

Mike

6 Canadian Capitalist

Mike: Thanks for the link. I really think you should add both REITs and emerging markets. Yes, both have done well recently but you can plan to have exposure to these sectors eventually and keep accumulating cash to buy into these sectors.

7 plonkee

I’m invested 75:25 in UK and world ex-UK index funds. Sure it’s a bit basic and probably not optimal, but I’m still young enough to do 100% equities, and I don’t have a lot of money to contribute regularly, so I can only be invested in a few funds. It’ll do for now.

8 laketrout

I’ve been saving to my RRSP in cash and GICs over the past year while I build a suitable amount to open a self-directed account. In the meantime I’ve been researching various asset allocation models. The plethora of models can indeed make your head spin.

My latest conception is a lazy version of the Yale/Harvard endowment portfolio.

20% Domestic Equity (XIU – Canadian large-cap)
20% Foreign Equity (IOO – Global large-cap)
20% REIT (XRE – Canadian Reit)
20% Commodities (GSG – GSCI)
20% Bonds (XSB – Canadian short bonds)

It’s a start… but a work in progress. I’m considering adding a global small-cap to balance out all the large caps but I’m trying to keep things as simple as possible.

9 FourPillars

Laketrout – that portfolio is very interesting.

What is your rationale for having only large caps in the equity portion? I personally prefer an all-index ETF which are dominated by the large caps anyways. As you say, you can add small caps later.

20% commodities – This is a lot, I don’t know what the right number is, but don’t forget your XIU has a lot of commodity exposure as well.

20% REITs – This percentage is a bit higher than most portfolios but I don’t disagree with it. Another reason (albeit stupid one) for me not having any REITs yet is my inability to decide how much to have. 5%?, 10%, 20% or more??

10 telly

Hmmm…not sure if it’s a philosophy per say but here’s our AA and our targets. We’ve got some work to do in rebalancing to get back to our targets.

33% CDN equities (target 25%)
41% US equities (target 45%)
23% Int’l equity (target 25%)
1% emerging markets (target 3%)
2% FI (target 2%)

11 telly

We don’t allocate any to REITs as we have plenty of RE holdings in our two rental properties.

12 laketrout

FourPillars –
I was looking for a global ETF that had world exposure and also included US equities – IOO seemed like the perfect fit and it also had minimal Canadian exposure (0.45%).
As IOO was all large-cap, XUI seemed to compliment it and had a lower MER compared to the full composite index XIC. Now that I think about it, XIC might solve my dilemma about how to add small caps to the portfolio.

About the commodities, I had been thinking about the large exposure XIU has to commodities but hadn’t decided on whether to reduce it. I kinda like the equal weighting to each asset.

Historically, this specific portfolio has returned just over 10% over the last 10 years.

13 moneygardener

I don’t think their is any rationale for a person who owns their own home to own REITS. Most Canadians probably hold too much real estate as it is…

14 moneygardener

I agree that bond can provide some dry powder for ‘market timing’. As far as steadying returns goes though….I don’t see the benefit if you have a long time horizon.

15 telly

mg, I believe you said you were reading Four Pillars of Investing (?). I don’t recall the numbers offhand but Bernstein provides some pretty insightful data that shows, even over the long term, bonds decrease volatility in a portfolio without significantly reducing returns.

That being said though, I am of the school of thought that believes that holding FI while still carrying a mortgage doesn’t make much sense. But that’s just our approach.

I only hold fixed income because my employer provides a pension in the form of a balanced fund which hold a portion of FI. In truth, my FI is probably higher as there’s a closed db pension as well, which is not included in our nest egg amount.

16 moneygardener

Hi telly, my point is with your word ‘significantly’. If one has a very long time horizon why would they want to reduce volatility and take a return hit, no matter how small. If equities outperform long term then, 100% equities must be the best long term approach unless your bond holdings serve a purpose such as a fund reservoir etc.

I will finish 4 pillars and post about this.

I agree with you regarding your mortgage point.

17 FourPillars

MG – You and I differ on this but I don’t consider my house value in my asset allocation. I can certainly see both sides of this argument but that’s the way I do it so I don’t have a problem adding REITs to my portfolio.

Telly – You think the same way as Financial Jungle (and MG) regarding holding a mortgage and FI. I don’t agree with this either which is why I have FI as well as a mortgage.

MG – I agree with the dry powder strategy – if there was ever a big bear market then I would certainly consider decreasing the percentage of FI to take advantage of it (over and above the effects of normal rebalancing).

That said, creating a reasonable asset allocation strategy (which I think we all have) and sticking to it, is more important than having the perfect strategy (in my opinion at least!).

Mike

18 moneygardener

That’s fair Mike.

..MG

19 FourPillars

Now that I think about it some more…

Bernstein recommends 25% FI for any type of investor in a tax sheltered account. However it seems to me that one of his reasons is that for someone who is retired and living entirely off their portfolio, they need to be able to survive a big dip in the markets during retirement. So if equities went down 90% and you have 100% equities then you will only have 10% of what you used to have and that might be a disaster. If you have 25% of FI then that should be enough for you to survive for a few years until equities rebound.

One of the specific recommendations he (and others make) for retirees is to have five years worth of expenses in cash at all times to be able to handle the situation described above. Depending on the size of your portfolio, this requirement alone could mean 15-20% FI at all times (in retirement).

Those reasons obviously don’t apply to a youngster like MG but as Telly said, according to historical returns, the extra risk of a 100% doesn’t give the commensurate extra reward. That said if you can handle the volatility then I’m not sure if you are really going against Bernstein if you have 100% equity and aren’t planning to retire for a little while.

He was also quoted in a MoneySense article recently as saying that you shouldn’t have fixed income in taxable accounts under any circumstances (because of the taxes) so if for some reason you don’t have access to a tax sheltered account or whatever then he recommends 100% equities.

Mike

20 telly

I need to get a hold of the book again, but I believe Bernstein (or maybe it was Malkiel) showed that, in some cases, even over the long term, a mixed portfolio produced a higher return with slightly less risk.

Again, I don’t hold FI but, if it weren’t for my views on holding a mortgage and FI at the same time, I would definitely hold FI, even if my time frame were long.

I’ll see if I can scrape up some examples. I’m beginning to cave and think I’ll pruchase Four Pillars…

21 FourPillars

Telly – I got it for Xmas :)

You’re right about the fact that equities don’t always win out. Over the long term like the last 80 years, having more equities was a better strategy for most 20 year periods but not all of them!

Mike

22 john

After many years of trading only stocks I have decided to be a bit more hands off and balanced in the future.

The hands off portfolio I want to evolve towards in the next few years will be

Canadian Bonds
XBB – 20%
TDB909 – 20%

Canadian Stocks
XIC – 10%
TDB900 – 10%

US Stocks
XSP – 10%
TD902 -10%

International Stocks
XIN -10%
TDB911 – 10%

The use of the TD plus i Shares makes it easy to balance (ie no fees for the TD efunds) and also hedges 50% of the US/ international vs currency

23 LiseBise

Wow, this was an interesting read. My AA is a bit simpler (I think).
40% Canadian equity
40% foreign equity (1/2 of that emerging markets funds)
20% bonds
Stocks are now all solid dividend payers as I’m now over 50 and focussed more on increasing my post-retirement income stream. Dividends are automatically reinvested for now.

Like John, I’m thinking of moving out of pure stocks. I’m probably going to experiment a bit with index funds, ishares and such this year.

24 Four Pillars

Thanks for sharing John and Lise.

Can you tell me why you are moving out of stocks and into more passive investments?

Mike

25 john

My move from being a stock picker to an indexer will be gradual an take a year or more. I have 45 plus different positions now.

Picking stocks is fun and I really enjoy it.

But my portfolio is a serious size now (I have been doing this for years) so it is time to go with the balanced portfolio approach. Indexes across bonds, Canadian and international markets (50% currency hedged) will be my new approach.

But there will always be a corner of the portfolio devoted to pure stock picking and speculation. I will likely just buy the picks on the margin to add to the excitement.))))

26 Four Pillars

Thanks John – I think your future portfolio looks pretty good.

Mike

27 LiseBise

I’m have a health problem and I’m finding it harder (and less fun) to manage my portolio. So, I’ve set up a few test portfolios that are more passive and I’ll monitor those for awhile before I decide what to do. That doesn’t mean I’m moving out of stocks… I’m just testing a few things out, one of which is the Globe & Mail’s 2-minute portfolio.

28 Four Pillars

Thanks Lise – that sounds like a good reason to go for a more passive investment strategy.

Mike

29 telly

Lise,

20% emerging markets sounds a bit scary to me. What’s your reasoning for such a high allocation to this ector if you don’t mind my asking?

30 telly

That should read “sector” above.

31 LiseBise

Telly, re. 20% in emerging markets. My reasoning is not the smartest financially speaking. You see, much of my behaviour is political or social, not ‘logical’ from a financial perspective. Shades of my old hippy days, I guess.

I invest in emerging markets because I’m passionate about giving 3rd world countries a chance to get out of poverty.

Yet, I also believe in a strong local economy, so I buy local and my charitable contributions are also local.

So, I figured the only 3rd world contribution I could make is to invest in their economies. It also sort of fed into my belief that it’s better “to teach them how to fish than to give them the food.” (I forget what the real saying is.)

It was a bit tricky because I also wanted to add the enviro lens, the human rights lens, etc. etc. But that turned out to be ridiculously complicated so I eventually just went with mutual funds.

I put 20% because that’s what I was ready to lose. Even if I lose it all, I’m still far better off than many of the people who live in these countries can ever hope to be in my lifetime.

The joke is my emerging market investments have done extremely well. My latin american funds in particular just boomed for awhile. A bit of a slowdown last year, but still doing pretty well.

32 telly

LiseBise,

I kind of see where you’re coming from…

Have you ever looked into microfinance as a donation / investment that doesn’t actually make up a portion of your portfolio? I like the Grameen Foundation personally (www.grameenfoundation.org). I totally agree that an investment in a 3rd World economy is an important contribution but I’m not sure I agree that that’s what you’re actually doing. Investing in emerging markets means that you’re investing in companies like China Mobile, Samsung, Petroleo Brasileiro, etc. but I’m not sure how much those investments are helping the least fortunate people of the World. It’s an interesting question though…

I would guess that 99% of African countries are not represented in any Emerging market index, thus, I wonder how much one is really investing in 3rd World economies when they buy an emerging market index?

I would think that if you’re ‘ready to lose’ 20% of your portfolio then you might think of using a portion of that to contribute to any one of various microfinance organizations out there and then think of your investments as holdings that you expect should produce profits / gains.

You’re right, emerging markets have been HOT, that’s why I’m a bit nervous to allocate so much of my own portfolio to this sector.

Anyway, thanks for sharing your interesting approach to AA!

33 FourPillars

Lise – thanks for the response – it was definitely not the answer I was expecting!

Mike

34 Dividends4Life

Now the tricky part – sticking to it through thick thin. :)

Best Wishes,
D4L

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