Asset allocation is simply creating a portfolio with holdings among a number of different assets such as stocks, bonds, real estate, or cash. The goal of asset allocation is to create a portfolio in a way that meets your particular needs, minimize risk, and meets investment objectives.
The three major asset allocation strategies are:
- Strategic asset allocation. A passive buy-and-hold strategy where asset weights are set for a long period of time and only rebalanced when necessary.
- Tactical asset allocation. An active, market-timing strategy that responds to changing markets by trying to take advantage of new trends.
- Core-satellite asset allocation. This strategy divides a portfolio into a core set of holdings of a few index funds or total market holdings with a few small satellite holdings that provide additional return or diversification for the portfolio.
I don’t want to sway any votes, but I did want to comment briefly on my own strategy. I primarily use the core-satellite strategy, with just a touch of tactical. By that I mean that a large portion of my investments are in core holdings that won’t change–a few index funds that cover the capital markets, a bond fund or two, etc. These are simply a buy-and-hold. But my satellite funds are smaller holdings that provide diversification, but they aren’t all necessarily expected to be held for 20 years. I use some small satellite holdings to work as some tactical moves to help try and capitalize on current trends.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I think the strategic asset allocation makes the most sense for the great majority of the investing public.
But the great majority of the public are also not on these blogs. These people, to me, are more savy then the general public and can be more proactive, taking a core satellite approach.
I think Millionaire Money Habits, Dave and Honest Dollar have it right.
I use Managed futures to build portfolios, which creates some non correlated diversification for client portfolios. This approach falls into the core satellite approach.
Sometimes I'll take a similar approach to the one you detailed, core with a touch of tactical, as well.
@Michael Blackburn - What's the symbol for your fund of funds?
I'm more like the core-satallite holding style and in for the long haul. I have about 10% of my portfolio for my own stock picking strategy just for fun, and 5% of that is speculative.
I have a Roth IRA and purchase precious metals. Beyond this, I'm still slightly afraid of other investments (lost a lot in the 2001 tech crash).
I chose the core-satellite strategy. I have most of my investments in a target date fund, and that is the core. The "satellites" are not really investments with the intention of increasing diversity, they are more "fun" and "tactical". Basically, the satellites are where I play with stock picking and other DIY stuff. The goal isn't to increase diversity but to increase my knowlege and involvement with my investments.
You're right, that example is a little misleading, and an amount that small is probably set aside for a different goal.
I was more or less referring to people who have substantial cash sitting aside that is exceeding emergency funds, and they have no other real plans for the cash than to sit there and earn interest.
That's a great article, and gives more detail on exactly what I was trying to say. One quibble, which is your point about analyzing your entire portfolio to determine your asset allocation. It definitely makes sense to do this cross-account analysis for all funds _*dedicated to a specific goal*_. In your posts' hypothetical example, you include the $12,000 savings account as a part of his potential retirement portfolio. It's likely that money in a savings account is either a six-months-expenses cash cushion, or a for some immediate-term expense, such as a down payment or a teenager's college fund. I doubt you would recommend someone keep their rainy-day money 90/10 in stocks/bonds.
I'm not a financial professional, but I get a number of younger colleages asking for money advice. If I preach anything, it's that having defined goals is the key to knowing where to put your money. If the money is for retirement and you're under 30, by all means put it in stocks, the riskier the better. If the money is for a shorter timeframe like a first down payment, 100% cash is the way to go. Chances are, you're working toward several goals at once; in that case, you divvy up the money and invest for each goal appropriately.
That is great advice Michael. I actually wrote a piece a while back on target date or lifestyle funds and how many people simply use them wrong and create a ton of overlap in their portfolio, not really doing any diversification like they think.
Lifecycle Funds: Look but Don't Touch
But it is probably time to do another post to talk about these types of issues again since it is very common for me to see people who are using these types of funds incorrectly.
Sure Jen, I figured you were not doing exactly what your first post sounded like. My motivation wasn't so much correcting you as getting an important piece of info "out there." From what I understand, it's a common mistake to have a target date fund as *part* of a 401(k). That's a no-no.
And you make an excellent point, that a fund-of-funds (FoF) can be more expensive than holding the component funds. That's something that I wish was a little more transparent: when you see the expense ratio on a FoF, is that the *additional* expenses of the FoF, or the *composite* expense of the component funds plus overhead? It makes it difficult to do an apples-to-apples comparison. If anyone can tell me if there's a way to tell the total cost of ownership of a FoF, I would really appreciate it.
For me, the constant-weighting FoF I use holds the fund family's premium-class funds, which carry a lower expense ratio -- and a significantly higher minimum investment -- than the fund classes my balances would qualify for. Thus, I chose to invest in the FoF, because *if* the expense ratio listed for the FoF is an additional expense to the underlying funds, I'm breaking even. If the expense ratio is the sum of the underlying funds ratio (doubtful), I'm way ahead.
Yes, Michael, I know you should own only target funds if you go that route. I should have expanded on what I meant. First, the target funds I hold are funds of funds, and the underlying funds are index funds.
Second, I took a close look at the expenses for my 401(k) options, and it turns out that I can get a lower expense if I invest my 401(k) in index funds as opposed to the target retirement fund. I am saving some money by adjusting my own asset allocation in my 401(k) instead of paying someone to do so. I check the target fund weights and adjust the 401(k) to match. As part of my end of year review, I will probably take another look at the 401(k) expense to make sure this still holds true.
As for holding a REIT - I wanted a little more exposure to REITs than the equity index would provide. The amount I hold isn't enough to completely throw off the target allocation, especially when you notice there's a slight 5-10% difference in asset allocations across target funds from different companies. So my equity exposure is still in the appropriate range.
It is generally considered A Bad Idea(tm) to hold both target-date retirement funds and additional funds. Target-date retirement funds are one-stop shopping, and should hold a little of EVERYTHING: Stocks, bonds, commodities, REITs, etc. If you purchase anything *in addition* to a target-date fund, you're saying "I, with my limited view of the market and minimal experience in portfolio management, know better the appropriate asset allocation than an investment company with armies of researchers and decades of experience." The reason for a core-satellite approach is the satellites provide exposure to market segments not covered in the core. But a target-date fund should already provide that exposure, so you're simply fiddling with the weighting of asset classes. You may be qualified to do that, but I know I am not.
So, in my current company 401(k), I use a target-date fund ONLY (albeit one with a date five years beyond my expected retirement date). However, in my Roth IRA, I use a low-cost constant-weighting allocation fund as my core. It holds four index funds: 55% S&P index, 15% each Bond, Total Market and International. I supplement that core by adding additional funds and stocks to achieve what I believe to be the appropriate allocation for my goal.
In short (too late); a target-date fund is not intended to be used for a Core/Satellite strategy, as it is already diversified in its internal allocation. If you own additional funds, you're taking on additional risk without providing significant additional upside. Look for a constant-weighting allocation fund or simply purchase multiple index funds to form your core. I've heard it said that you should have 90% of your portfolio in the core, and 10% in the "speculative" area. Theoretically, you're exposed to very-high upside with a loss limited to 10% (above any market risk inherent in your core allocation)
i use strategic.
40% S%P index
40% EAFE index
10% small cap index
5% Int'l REIT index (40% domestic)
5% Diamonds (sold on may 1st and rebuy Oct 1st)
I voted Strategic Asset Allocation, but there is a touch of Core-Satellite to it. The bulk of my retirement savings are in index/target retirement funds, but I do own a REIT to add that to the mix.
I voted Core-Satellite. My IRA and 401(k)s are in index funds that cover the whole market (equities, bonds, and international). My brokerage portfolio is half in ETFs that cover the market, and half in individual stocks. I invested in individual stocks to learn the ins and outs of picking quality stocks, but I don't expect to add much more of my future savings to individual stocks.