The advice provided by financial advisors to retirees or near-retirees included keeping any money you need in the next 2-3 years in cash (or cash equivalent investments). Money needed in the subsequent decade should be invested in safe, fixed-income investments such as bonds. The rest should be invested in stocks to beat inflation.
But what is the recommended allocation for people with a longer time-horizon like myself?
When I first started contributing to my 401k in 2001, I was clueless about how to invest. (Some would argue I still am. He he.) I started with the "conventional wisdom" that I should subtract my age from 100 (or 110) and invest that amount as a % in stocks. I initially started with 70% in the S&P500 index fund, 15% in the intermediate bond fund and 15% in the US Treasury Fund.
I subsequently readjusted my future contributions to include small-cap and mid-cap funds, but did not re-align my existing investment funds to match my new targets. As a result, my 401k asset allocation last year was: 57% US Large Cap, 2% Mid-Cap, 13% Small-Cap, 16% Intermediate Bond Fund and 12% US Treasury Fund.
Clearly, my 401k was due for a significant re-alignment.
My 401k administrator's (Bank of America fka Merrill Lynch) website provides the following allocation recommendations based upon one's own risk tolerance.
Unfortunately, the above recommendations aren't very helpful since they only give a breakdown between stocks-bonds-cash based upon one's risk tolerance. It doesn't take into consideration of one's investment time horizon. Additionally, it gives no guidance with respect to the sub-allocation within equities and bonds.
CNNMoney's Asset Allocation Calculator provides a better guideline for allocation based upon age and risk tolerance. Based upon my age (mid-30s) and risk-tolearance (aggressive), CNNMoney recommends:
But is this allocation too broad and overly simplistic? Possibly.
For example, this diagram doesn't differentiate between growth vs. value equity funds and between short-term vs. long-term vs. mid-term bond funds. This diagram also completely ignores mid-cap funds and other specialty asset classes such as commodities, REITS and natural resources.
Fortunately (or unfortunately, depending upon your perspective), most of the funds in my 401k plan aren't very attractive. For example, a good chunk of the selection of funds in my 401k either have high expense ratios (i.e., greater than 1%) or are front-loaded. There are also no specialty funds available.
This limitation of options available in my 401k plan is a blessing and a curse. Having too many choices may cause analysis paralysis. And with respect to finances, I believe in KISS ("Keep It Simple, Stupid").
So using the CNNMoney allocation as a basic blueprint (with a small tweak), my current 401k allocation looks like:
|Investment Fund (Classification)||Actual % of Portfolio||Target %|
|DODFX (Int'l Multi-Cap Value)||18.02%||20%|
|DODGX (US Large-Cap Value)||19.15%||20%|
|BTIIX (S&P500 Index)||20%||20%|
|NBGEX (Small-Cap Blend)||21.33%||20%|
|PTRAX (Intermediate Term Bond)||16.02%||15%|
|MLTXX (US Treasury Fund)||5.48%||5%|
A friend (who is the same age as I and who has 100% of her portfolio in equities) commented that I'm too conservative. Maybe. But I take solace in the fact that since 12/31/07, the S&P 500 index is down 17.79% but my portfolio is "only" down 13.99%. Is it a coincidence that I'm only down 80% of the broad market index? I think not.
Besides, by sticking to my current allocation, I expect to have the recommended amount of my investments in cash or cash equivalent securities by the time I retire, through dollar cost averaging over 3 decades, rather than a panic-sale in my old age. I also try to follow Warren Buffet's advice to measure myself by what he calls the "Inner Scorecard" - judge myself by my own standards, not my friends'.
My current allocations are pretty much in align with my target so I probably won't need to adjust it anytime soon. But I suspect that the international fund will take a hit in the upcoming months and year(s).
Perhaps next year, I will shift some of my large-cap US fund and my bond fund allocation to the international fund. Additionally, in order to diversify further, I'll consider investing in other investments that are unavailable in my 401k in my Roth IRA. I guess that means I should start contributing to my Roth.