Investment Management Using Asset Allocation Targets

Pool deck on the cruise

I use my asset allocation as a tool to manage my current and future investments.  I always aim to have a fixed percentage of my investments in each asset class.  In my previous post, I presented my asset allocation and target percentages for each asset class.

As the value of various asset classes rise and fall, I will buy or sell to keep the portfolio balanced to the target percentages.

Let’s take a look at how this works with an example.  If my large cap US funds depreciate to 9% of the entire portfolio (instead of the target 11%) while my developed international funds appreciate to 22% of the entire portfolio (instead of 20%), it is time to make some trades.  I need to sell 2% (or $20,000 in a $1 million portfolio) of the developed international funds and use the proceeds to buy 2% of the large cap US funds.

I have found the easiest way to track my asset allocation is with the free investment management tools at Personal Capital (review here).  I could use the built in Personal Capital asset allocation tool:

Asset Allocation Summary

 

It works really well, and gives you an immediate overview of all the asset classes in your portfolio.  Asset classes like US small cap value and emerging markets are reported separately within the US Stocks and International Stocks groupings.  The US stocks breakdown in my portfolio looks like this:

 

US Stock Allocations

 

Instead of using Personal Capital’s awesome built in asset allocation tools, I get a little nerdy.  I developed my own spreadsheet.  I simply copy all my investment holdings from Personal Capital and paste the holdings into my “portfolio analysis” spreadsheet.

Before Personal Capital, it was an arduous process to log in to multiple brokerage accounts, IRA’s, 401k’s, and health savings accounts for Mrs. RootofGood and myself.  All the far flung accounts presented their data in different formats, and it was a rather time consuming chore to download, copy, and paste the data into my portfolio analysis spreadsheet.  All those manual operations lend themselves to data entry errors as well.  Not a pretty picture.  I’m glad that Personal Capital consolidated all my accounts into one screen, because it makes this particular task (analyzing my asset allocation) incredibly easy and streamlined.

Here is how Personal Capital presents the holdings data:

Personal Capital holdings 11-17-2013

I have asked Personal Capital for a download function to get a CSV or XLS file of holdings data, but they don’t have the functionality yet.  In the meantime, I copy and paste the holdings data and it works for me (huge time saver).

After I dump the holdings data into my portfolio analysis spreadsheet, I can see my target asset allocation percentages and my current asset allocation percentages side by side.  I created a column that shows me the exact amount I need to add or subtract from a given asset class.

The graphic shows today’s current asset allocation in my portfolio with a hypothetical $1,000,000 portfolio value.  That gives us some nice round numbers to discuss.

Current Allocation

 

Overall, things look pretty good (given I haven’t touched my investments for 3 months).  I’m underweight on the US large cap allocation by 0.8% (10.2% currently versus 11.0% target) and overweight on the US large cap value allocation by 1.0% (12.0% currently versus 11.0% target).  I need to sell some US large cap value funds and buy some US large cap funds.  The US REITS are 0.4% underweight (5.6% currently versus 6.0% target).  The other asset classes don’t deviate more than 0.2% from their respective targets, so I probably won’t do anything to them right now.  Keep it lazy, folks.

What do I actually need to do to get all my holdings close to their target allocation percentages?  I’ll take a little shortcut and head straight to one account and do all the trading there.  Mrs. RootofGood’s awesome 401k has access to institutional share classes of Vanguard funds in the large cap, large cap value, and US REIT sectors.

I need to sell $10,000 of the Vanguard Value Index Fund – VIVIX (the large cap value fund) and then buy $7,000 of the Vanguard Total Stock Market Index Fund – VITSX (the large cap fund) and buy $3,000 of the Vanguard REIT Index Fund – VGSNX (the US REIT fund).

TIP: If you want to use these funds in your own asset allocation, find the equivalent funds in “Investor” or “Admiral” share classes.  These ticker symbols are for the “institutional” share class through Mrs. RootofGood’s 401k.  Unless you have a cool $5,000,000 per fund, you can’t get in as an individual investor.  Investor and Admiral class shares have a $3,000 and $10,000 minimum initial purchase.  In a future article I will provide you with mutual funds in each of the asset classes that I consider to be the best available.  

One of my investment goals is to keep the portfolio management simple.  That’s why I don’t feel compelled to get to my exact target asset allocation in every asset class.  If each asset class is within a few tenths of a percent of the target, that’s good enough for me.  Any more micromanagement and you’ll feel like you are picking fleas off a dog – a whole bunch of moving targets zigzagging all over and you’ll waste a lot of time chasing the little buggers without a lot to show for it at the end of the day.

That’s why I only bought $7,000 of the large cap and $3,000 of the US REIT.  I should have bought $8,000 of the large cap and $4,000 of the US REIT according to my analysis spreadsheet.  I chose not to bother with buying the exact amount since I would have to go to multiple accounts and complete additional transactions to reach the exact asset allocation targets.  Being just a small bit off (around 0.1%) is okay.

What if I held all of my large cap value allocation in my taxable account and I was sitting on $60,000 of capital gains?  Selling $10,000 of the large cap value fund would result in $5,000 of capital gains that might cost me a lot at tax time.  As a result, I want to avoid selling highly appreciated shares.

There is a different way I could get back to a balanced portfolio without selling anything.  I can simply direct new investments into the underweight asset classes.  In our case, Mrs. RootofGood is still working, and contributes around $2,000 per month into her 401k (employer match plus employee contribution).  She can direct her monthly 401k contributions into the funds that are most underweighted.  Since the large cap asset class is $8,000 below the target value and the US REIT asset class is $4,000 below the target value, she can direct 67% of monthly contributions to the large cap fund and 33% to the US REIT fund.  After six months, she will have contributed $8,000 to the large cap fund and $4,000 to the US REIT fund.

In this latter example, you may have noticed I didn’t do anything to reduce the large cap value’s overweighting of $10,000.  Time for a diet!  I’m going to starve the asset class by not feeding it more contributions.  With new contributions going elsewhere, the values in the other asset classes in the portfolio will rise, and the large cap value balance will remain about the same (barring big moves in the market).  By directing new investment purchases into the most underweight asset classes, it is possible to slowly bring the portfolio into balance.  It’s like steering a large ocean liner – you make small corrections on the rudder to keep on course.

And that’s how I balance my investment portfolio.  As you can see, after three months of ignoring my portfolio, it is still mostly balanced with just a few asset classes out of whack.  I don’t spend a lot of time managing my investments to a tight asset allocation target. I don’t think it increases investment returns to rebalance too often.  I think it’s pretty cool that the portfolio produces enough returns to fund our living in perpetuity, and I don’t have to spend hardly any time micromanaging the investments.

Emotion and market timing can be the investor’s biggest enemies.  Using a target asset allocation takes the emotion and thinking out of investing.  I recognize I’m no smarter than the thousands of computers and active traders at investment banks and hedge funds.  My investing goal is to keep my trading costs and investment management expenses to a minimum, and allow the investments to grow long term.

Figuring out what method of rebalancing works best for you might take a little time.  There are free tools out there like Personal Capital to pull investment data from your IRA’s, 401k’s, and brokerage accounts and consolidate it in one place.  Personal Capital’s built in asset allocation overview might be enough for you to manage your asset allocation and rebalance your portfolio.

In this post on my portfolio’s dividends, I included a chart that shows specific mutual funds and exchange traded funds (ETF’s) I hold in each of the asset classes in my asset allocation.

 

 

Do you have a similar (or better!) method of managing a passive index fund portfolio like mine?  What are your rebalancing rules or triggers?  

26 comments

  • Pingback: Snapshot of Root of Good’s Diversification and Asset Allocation | Root of Good

  • I have a google spreadsheet that functions similarly, using the =GoogleFinance functions, I just have to keep up-to-date on the number of shares of each fund I have and the spreadsheet pulls all the data for me. I have google highlight the “actual” row in red when I’m off by plus or minus 5% – and that’s what triggers a rebalance for me. I do it mostly through two accounts – rollover IRAs for Dad and myself. There are no transaction fees for us to buy sell Fidelity funds, I just make the change.

    • I tried to do something like that a long time ago, but it was too clunky for my portfolio.

      My problem was keeping the number of shares correct. I automatically reinvested dividends so the # shares would always go up slightly at the end of each quarter. And with new investments trickling in monthly with 401k contributions, it got messy quickly. Add that on top of a total of 37 different mutual funds across 15-20 different accounts, there were probably 50-60 different individual holdings.

      And I have these “special” proprietary (ie crappy) investment options in my 401k and 457 plan that don’t have ticker symbols that google can pull.

      All these obstacles put me on the search for a more streamlined solution. That’s where Personal Capital is really helpful, because it pulls the data all into one place. Then my customized spreadsheet can “read” it when I copy/paste it into my spreadsheet. There’s still that manual step of copy and pasting the data, but it is really just that one step. Now it is incredibly simple to check out and analyze my asset allocation in depth.

  • Pingback: Carnival of Money #8: Cyber Monday Edition | Carnival of Money

  • Pingback: Lifestyle Carnival | Hurricanes, Panties and Dollars

  • Pingback: Carnival of Passive Investing #36

  • I have a couple of questions about classification. Under your self defined asset classes, “mid cap” and “core” do not exist. How do you resolve that into target asset classes? I do not see how you use the second image, us stock classes, to put in your asset target vs current table. Also, wouldn’t a small cap fund also include small cap value stocks?

    As I set up my own asset class targets, I will probably adopt it to the output classes from Personal Capital.

    Thanks. Enjoy your blog.

    • For mid cap, I treat it as small cap in my portfolio. I try to buy small cap funds, but I also own the “extended market” funds which are mid+small.

      Yes, a small cap fund includes small cap value and growth.

      I pull all the investment holding data from Personal Capital using a copy and paste, and put it into my own customized spreadsheet that converts the asset allocation data to the categories I use (shown in the last table in this article).

      If you don’t want to go the route of building your own asset allocation model and spreadsheet, you can do just fine using the recommendations in Personal Capital’s investment tools and rebalancing to their recommendations. It’s not too different than what I personally do. My portfolio is similar to the “very aggressive” portfolio strategy (I think that’s what they call it). They have a little less in international, and a few other small differences.

  • Sorry I’m late to the party. Does the Personal Capital holdings data screenshot show your entire investment portfolio – all tax deferred and taxable accounts?

  • I like your system here although personal capital for me isn’t the easiest user friendly system :O..
    I track my net worth on a spreadsheet, old school I know ha although find it works okay for me, takes about an hour a month..

    One thing I need or should look at is my allocation although I’m heavily overweight to property at the moment, which will help use leverage & then start to generate cash flow.. Shares or stocks can do this well too 🙂

  • Hello Sir,

    Great blog, I am really enjoying reading through it, bunch of good ideas and recommendations. Bellow is the link to a Marketwatch article by Paul Merriman, whose equity allocation you used to create your portfolio (at least that is my understanding). The article is pointing out that an investor might be better of without ever re balancing the equity portion of the portfolio. Not sure if you had read the article before, but really curios to know your thoughts on this subject?

    http://www.marketwatch.com/story/why-rebalancing-could-be-a-huge-mistake-2013-11-20

    Regards,

    Dani

    • It probably is mathematically better to not rebalance individual equity asset classes. The reason is pretty simple – the biggest winners grow to consume an ever increasing proportion of your asset allocation. They have higher rates of return, and push up your overall average portfolio return.

      That would come with more risk (imagine a portfolio that’s mostly small cap value and emerging markets, for example). Merriman said he didn’t see higher risk but I bet if you look at it mathematically over the last 100 years, not rebalancing comes with higher volatility (a standard measure of risk).

  • Hi Justin,

    I’m a personal finance blogger from Singapore and your blog continues to be one of my favourites to read around the world. Using asset allocation to guide your investment decisions is a great approach and one I intend to employ in my own portfolio as well. It’s a pity we don’t have a free tool like Personal Capital here in Singapore and I do my tracking on a Google Spreadsheet. Works fine but it would be nice to have a more graphical illustration of the various assets.

    Cheers,
    TFS

    • Personal Capital is a neat tool, but nothing you can’t do with Google Spreadsheets like you’re saying. I actually use the asset allocation data that Personal Capital provides to feed my own asset allocation spreadsheet.

    • Intuit’s Mint.com is another tool to try. Its free as well.

  • Great article. But, I do not see any Bonds (US and International) in the portfolio? Why is that, can you explain? Do you plan to have Bonds in your portfolio as you get older?

    • I’m 35, and planning for 5-6 more decades of spending down my portfolio. Bonds don’t pay much more than inflation today, so I can’t justify them in my portfolio right now. Our spending is flexible enough that I could decrease living expenses if the market crashes suddenly, so I can get by on almost 100% equities (other than a 1-2 year cash reserve).

  • Hello,

    I’m at the early stages of the accumulation phase and I’m trying to set up a similar portfolio based on Paul Merriman recommendations, which are obviously very similar to yours.

    So here is what I’m pondering about, whether to use a mirror asset allocation when looking at tax deferred (401k and IRA) and taxable accounts (i.e. look at those two separately and have each of the asset classes in both of them in proportion to the target asset allocation). Or to see everything as a single portfolio.

    Like you are planning to do, the funds from a taxable account are the most accessible and would most likely get used up first. Which would leave the tax deferred to grow for another 10-15 years.

    That made me think mirror approach would be better. Because let’s say you have enough money in your taxable investments to allocate 30% of your entire portfolio in a taxable account. If you look at it as a single portfolio, you might end up with only 3 equity asset classes in your taxable portion, which you are planning on drawing down first. Obviously that portion would have different returns than the deferred portion of your portfolio, which would hold the remaining 7 assets classes.

    Let’s say for example purposes, all you had in tax deferred accounts was emerging markets, international small and international value, and everything else was in tax deferred. Taxable portion might significantly under perform your tax deferred account, and thus leave you with less money that is available to you immediately without any penalties on early withdrawal.

    So I’m having a hard time wrapping my head around that, and determining what makes the most sense. How do you keep your asset allocation in check in regard this?

    Obviously, you’re a smart guy, and I’m really interested to hear your thoughts in regard to this. This might be a good subject for one of your future posts as well…

    Regards,

    Dani

    • I treat my taxable and tax deferred accounts as one complete portfolio. Some less tax efficient investments end up in the tax deferred portfolios. When it comes to rebalancing, you can sell overweight positions within the taxable account and rebalance tax free as necessary within the tax deferred accounts.

      You have a valid point about different rates of growth in taxable vs tax deferred. The tax deferred might grow rapidly while the taxable account shrinks. You could intentionally keep more than just 3 asset classes in the taxable account to mitigate that risk.

  • At the end of this great post you say:
    In a future post, I will describe specific mutual funds and exchange traded funds (ETF’s) I hold in each of the asset classes in my asset allocation.

    Did you ever do this? I haven’t been able to find it (although I am new to rootofgood)

    Thanks,
    Kevin

      • Thanks Justin
        I enjoyed this page as well!

        One of the areas I am struggling with is how the Roth Conversions work. I still have about another 10 years of work before retirement. My spouse and I both max our Roth IRAs and try and put as much into the mortgage and then the 401K as possible. This is in the hopes of having our house in silicon valley paid off by my retirement. One of the issues we ran into this year is that we could not qualify for the Roth IRA due to our combined income. Is there some easy reading on how to navigate the Roth conversion? It seems tricky and the rules for what you can do and how much you can convert seem to be quite random in regards to avoiding breaking rules and getting an audit. I have a 401k rollover which I think may make the conversion harder or reduced.

        Confused,
        Kevin

  • Heather Dahlke

    Justin- thanks so much for the blog! I have been slowly reading through all of the post and I am learning so much.
    I have a question about keeping individual stocks in an investment portfolio. My husband and I both work for a large company that offers both Employee Stock Purchase and annual compensation in the form of Restricted Stock Units. We are long time employees and have accumulated quite a bit of company stock. I am a manager so a good portion of my annual compensation is awarded in RSU’s that vest annually into more company stock.
    Recently we have been selling our ESPP shares immediately and using the money to pay down our mortgage. Since we get the shares at a 15% discount it makes sense to buy them and then sell for csh.
    My question is should we be selling the share we have accumulated so far and re-investing that money into some sort of mutual fund that gives us a greater diversification? Our plan for this money is to live on it until we can access our Roth ladder we will start when we retire.
    Thanks in advance for the help!
    Heather

Leave a Reply

Your email address will not be published. Required fields are marked *