My Asset Allocation (Part 1)

Many of you will already be familiar with the idea of asset allocation – I don’t need to repeat the excellent explanations already out there (here’s a great primer from Bogleheads), but I did want to explore how I arrived at my own asset allocation and how you might go about thinking of yours.

I think of asset allocation in six steps, and will walk through each of these in this two-part series:

  1. Why are you investing? What are the goals?
  2. What broad asset categories do you want to invest in? Stocks vs bonds, US, UK, International, etc.
  3. What are your percentage targets for each of those asset categories?
  4. Which account types will you use for each asset categories, considering tax treatments?
  5. Which funds will you use in those accounts to achieve the overall asset allocation?
  6. How and when will you rebalance to maintain your target asset allocation?

Why am I investing?

My long term objective is retirement – ideally an early retirement in my early 50s. That’s far enough away for me (15 years, give or take) that I’m investing for the long term. Since I’m hoping for a long retirement, I’m also not planning on a super-conservative asset allocation immediately when I retire.

This pushes me towards an investment approach that accepts volatility in exchange for higher returns – mostly equities.

What asset categories do I invest in?

Personally, I keep it simple – stocks and bonds from across the world, mostly via index funds. There are lots of other asset classes you could look at: real estate, cryptocurrency, commodities, etc. To me, these add complexity (including tax complexity) without a good reason.

In particular, I’m hesitant about investing in anything that doesn’t have underlying growth. A company wants to be profitable, a gold coin or a bitcoin just wants to sit there. There’s a place in some portfolios for hedging using these kinds of investments, but for me, keeping it simple makes more sense.

For real estate, I don’t want the hassle of actually owning buy-to-let property at this stage in my life – I have enough work with my day job, and want to use my spare time for things I enjoy as much as I can. I can see an argument for REITs (in a US/UK tax efficient location!), but owning a house within London commuting distance is enough real estate exposure for me.

That leaves me with plain old stocks and bonds, which is a nice place to be.

What are my asset category targets?

I like the simplicity of a 4-fund portfolio, splitting between US vs International stocks and US vs International bonds. However, I’m living in the UK and intend to live here indefinitely – so how does the UK fit into that?

There’s one school of thought that “true” index investing is simply matching the market – trust that the mass of investors has it about right, and we should match the average. For stocks, that means about 56% in the US, 7% Japan, 5% China, 4% UK, and so on down the list, matching global market cap. This is a completely logical approach, and I honestly can’t fault it.

But, I like a bit of tweaking. Not going too far off the reservation, but working on the edges. I’m also considering which investments are easy to buy at low cost in the accounts that are available to me, working within the various restrictions from both the US and UK.

I’m of the strong opinion that the exact percentages of an asset allocation don’t matter all that much – what really matters is that you pick something you can live with and stick with it. Where value really gets eroded is if you keep changing your allocation, chasing today’s hot categories, selling low and buying high. I’m certain that my allocation isn’t the best possible allocation – nobody knows what the perfect allocation is except in hindsight. But it’s good enough and I can stick with it.

For me, that winds up looking like this:

The first question is the overall stocks/bonds split – I go with 90/10 for now. This is aggressive, but a) I don’t need this money until retirement; b) I have no worries about job stability – I can’t see any plausible scenario where I unexpectedly need this money; and c) I know my own risk tolerance. I’ve tracked my investments through both 2008 and 2020 crashes, and I didn’t sell, I kept buying every month. So I’m comfortable with only 10% bonds at this point – I will increase that percentage in future as I enter retirement. You may want something less volatile, and that’s totally ok. You might also be comfortable going 100% stocks – if that works for you, also great.

Getting into the components of that overall split: bonds first, because they’re easy. I have a simple 50/50 split between US and International bonds. Bonds as a whole are only 10% of my portfolio, so any adjustments here are tiny – there’s not much practical difference between 5% and 5% vs 7% and 3% or whatever other allocation, as long as there’s some of both. So I keep it simple.

Update 14Apr21: Based on my research into how to manage Required Minimum Distributions, I’ve decided to move as much of my bond holdings as possible into my TSP (similar to a 401(k)). The TSP doesn’t have an international bond option, so I’m now using 10% US bonds, no international. I don’t expect this to have any significant impact – I’ll move towards 5% US, 5% international once I eventually roll this over to a Traditional IRA.

For stocks, I split into 3 big buckets, with two of them further subdivided – percentages are of total portfolio, so they add to 90%, with the other 10% bonds.

  • 45% US stocks
    • 25% is large cap
    • 20% is mid/small cap – this is overweighted because they tend to have higher long term returns, albeit with higher volatility. I’m happy to ride out the volatility. It’s also easy to buy US mid/small cap in cheap index funds – much harder to do that for other countries. Edit 18Aug21: I’ve since decided to revert to the index weighting – my only tilt now is UK. I’m not convinced that the mid/small cap premium isn’t already priced in, so I’m going full Boglehead.
    • On the whole, this is close to the US’s overall market cap (50% of equities instead of the actual 56% – close enough for me)
  • 10% UK stocks
    • This is almost double the UK’s representation on the global market, but I’m deliberately choosing a bit of home bias.
      • A little of this is because a component of this allocation is individual stocks in my S&S ISA, and I am more comfortable doing individual stocks in a country I understand, plus the fees are lower for UK stocks.
      • A little is for currency fluctuations, although most big UK companies are hugely exposed to currency risk – they’re big because of large non-UK operations, it’s tough to get really big just within the UK.
      • And a little is basically just rooting for the home team – I’m ok with that 🙂
    • This is very nearly all large cap, with just a tiny bit of mid/small cap through index funds. I’ve looked at adding in more mid/small cap and might do that in the future, for the same reason as for US mid/small cap. For the moment, it’s more of a pain to find a good mid/small cap UK fund – what I’ve found is pretty expensive and/or a PFIC that I don’t want to hold outside my UK pension. I’m also not comfortable picking individual mid/small cap stocks, at least not yet.
  • 25% Other Developed International
    • This is almost exactly the remaining market cap for developed economies, after taking out the US and UK. I’m not taking any particular bets on which developed economies will perform better than others, spreading my investments across the globe.
      • For purely mechanical reasons, I’m underweight on Canada – that’s just because the TSP I fund doesn’t include Canada, as it tracks the MSCI EAFE (Europe, Australasia, Far East) index, and the I fund is a big part of my international investment. I briefly looked for Canada-only funds to fix this, but didn’t find anything. Canada’s stock market isn’t big enough that this worries me – sorry Canada!
  • 10% Emerging Markets
    • This is also almost exactly the overall emerging markets market cap. I’m hopeful that some emerging markets will outperform the broader stock market, but also realistic that some will underperform. I’m not placing any bets on which are which.

Within all of the above, I also allow myself up to 5% “fun money” – this could be individual stocks, sector specific funds, etc. At the moment, the only thing I have in this bucket is some RSUs from an old employer which are about 1% of my total investment, but if I want to buy a little GME to the moon, I’ll allow myself to do it 🙂

For my answers to the second half of the questions, please continue on to Part 2.

5 thoughts on “My Asset Allocation (Part 1)

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