This is a continuance of the earlier thoughts on "Asset Allocation,"
and "Choosing funds, fixed and taxable,"
http://socialize.morningstar.com/NewSocialize/forums/1/2508002/ShowThread.aspx?mrr=1208117890
As I offered earlier, I don't expect anyone to agree with what I am offering here, or take anything I offer as a quick fix to asset allocation. All I am offering is my reasoning, so take it with however many grains of salt you feel worthy.
This is where I may get a bit unconventional. As I offered earlier, I may have taken William Bernstein's statement about anyone claiming to be on the efficient frontier as frolicking with the Easter Bunny and talking to Elvis a little further than he intended. However, after reading all I have read on the Efficient Frontier, and setting a portfolio up per historic returns, correlations, &c., it is my opinion there is no such thing as the ‘Optimal Portfolio'. My only concern over anyone trying to asset allocate on the Efficient Frontier, is their chasing after the most recent data, which would favor the most recent high performers. Even this is no huge concern, as it still leaves the investor diversified. However, it may not work out as well as setting the percentages and sticking with them. Bernstein's Vanguard Portfolio offered in his "The Four Pillars of Investing" may offer an allocation set in percentages that will be as, or even more efficient today, as one that takes into consideration the returns since 2002 might lean more toward the higher returning asset classes for this period which would more likely than not be the lower returning, and more volatile asset classes going forward.
For reasons such as this, setting the percentages requiring you make judgments as to what would be better served with because of more recent returns, valuations and such, as well as many studies that have shown holding equal percentages in the asset classes you choose to invest in offers nearly as efficient an asset allocation as the hindsight 20/20 allocation, I chose equal percentages in my basic model portfolio.
For the stock allocation for this portfolio, I simply went with historic data which shows the benefits of holding a 4x25 portfolio, equal percentages of large blend, large value, small blend and small value as opposed to 100% S&P 500, and extended this out as far as I could using Vanguard funds. I also accepted this historic data showing the blends offer better returns than the growth indexes, especially in small caps, without question -- and possibly even with a little bias, as I have always been more a value type investor.
For the US and using Vanguard funds only, this is fairly straight forward. However, as opposed to going with large value, I chose mid-cap value as the newer offering for mid-cap value more closely represents Fama/French large value. Fama/French large value is both more valuey, as it reaches for the 30% highest value of large-caps, and smaller than Vanguard's Large Value fund;
- Vanguard 500 Index (VFINX)
- Vanguard Mid-Cap Value Index (VMVIX)
- Vanguard Small Cap Index (NAESX)
- Vanguard Small Cap Value Index (VISVX)
The small-cap funds Vanguard offers are not as small as the Fama/French indices. The small value index fund is however as valuey as DFA's Small Value and around the same size and close to as valuey as DFA's Small XM Value;
http://www.ifa.com/Media/Images/PDF%20files/Vanguard_vs_msci%20(2).pdf If you would like to take a bit more risk, and go with micro caps for the small blend portion, Bridgeway offers a micro-cap fund, and at least as we have discussed here in the past, good management;
- Bridgeway Micro-Cap Limited (BRMCX)
The expense ratio for this fund is kinda high, 0.84, but for those looking at add the meat of micro-caps, and believe the higher ER and trading expenses worth it, I personally think this is a good way to go.
As far as international funds, I just simply went with what I could find using Vanguard, and still using equal percentages and carrying this out to domestic/international as well, as I do not think I could guess the Efficient Frontier going forward. And, like I said, I think the major risk reductions, as far as volatility risks go, come from fixed income and possibly commodities.
My old friend raddr had something to say about how internationals helped to diversify a portfolio as well;
http://raddr-pages.com/research/InternationalDiversificationImprovesSWR.htm As I offered earlier, it may seem odd to look at the Safe Withdrawal Rate (SWR) to determine risks for a nest egg builder, but you have to recognize the need that might arise from losing your income and need to depend on your savings to get you through.
An equal allocation to internationals makes sense as best as I can tell;
- Vanguard Developed Markets Index Fund (VDMIX)
- Vanguard Emerging Market Index (VEIEX)
- Vanguard International Value (VTRIX)
- Vanguard International Explorer Fund (VINEX)
I haven't explored other fund families to find better small cap exposure in internationals than Vanguard's International Explorer. It may be possible there are low cost funds out there from dependable fund families that reach smaller of more valuey than Vanguard's. And, of course there are always DFA's if you really feel the need to invest what turns out to be extremely small percentages in international and emerging markets small value on the Efficient Frontier most DFA advisors follow.
My total portfolio using Vanguard funds only comes out to;
- Vanguard 500 Index (VFINX)
- Vanguard Mid-Cap Value Index (VMVIX)
- Vanguard Small Cap Index (NAESX)
- Vanguard Small Cap Value Index (VISVX)
- Vanguard Developed Markets Index Fund (VDMIX)
- Vanguard Emerging Market Index (VEIEX)
- Vanguard International Value (VTRIX)
- Vanguard International Explorer Fund (VINEX)
- Vanguard REIT Index (VGSIX)
- Vanguard Precious Metals (VGPMX)
- Vanguard Energy Fund (VGENX)
- Vanguard Inflation-Protected Securities Fund (VIPSX)
- Vanguard Short-Term Investment-Grade Fund Investor Shares (VFSTX)
As I offered, these are my thoughts. The percentages you would hold, not only fixed income, stocks and commodities, but also the different stock asset classes would depend on your personal beliefs and comfort levels, as I showed with the ‘Compromised Know Nothing Portfolio‘;
- 35% Vanguard Total Stock Market Index (VTSMX)
- 5% Vanguard Mid-Cap Value Index (VMVIX)
- 5% Vanguard Small Cap Value Index (VISVX)
- 5% Vanguard Emerging Market Index (VEIEX)
- 5% Vanguard International Explorer (VINEX)
- 5% Vanguard REIT Index (VGSIX)
- 20% Vanguard Total bond index (VBMFX)
- 10% Vanguard Inflation-Protected Securities (VIPSX)
- 10% Vanguard Short-Term Investment-Grade Fund (VFSTX)
The same would hold true for choosing managed funds over index funds in these offerings. Each person has their own reality. If you feel you can choose a managed fund in advance that will beat or increase the risk/return of any of the Vanguard index or managed funds offered here, that is a personal choice we must make -- the same as holds true with these portfolios -- nothing is written in stone.
Chin
originally posted here;
http://socialize.morningstar.com/NewSocialize/forums/1/2508002/ShowThread.aspx?mrr=1208117890