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Asset Allocation Plan

7845 Views 16 Replies 6 Participants Last post by  Rickson9, 
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I've been working on an asset allocation plan for some money I'm planning on investing, so I'd thought I'd share it with this forum:

The overall asset allocation I'm looking at is 65% equity and 35% bonds. This is heavy on bonds for someone my age, but the money is necessarily just for retirement, since there's a real possibility some or most of it could be used for a downpayment on property in the next 5-10 years. I'm also taking into account Graham's advice to stay within a 25-75 range for each section. At this point I'm not looking at other investment types; REITs don't really interest me and the Canadian equity portion gives me lots of exposure to general commodities. Cash isn't included as a percentage allocation, since I'll be holding a fixed amount with any excess used to purchase more assets at rebalancing times.

Speaking of rebalancing, the general rebalancing strategy is to do so 1-2 times per year, with an additional rebalance triggered if an asset is over 50% overweight, although I may still change this.

Specific Allocation (All Percentages of Total):

General Equity - 60%
20% XIC - iShares CDN Composite Index Fund (I like the greater breadth of XIC, but XIU has much better volume/liquidity and a slightly lower MER, so I'm not sure)
20% VTI - Vanguard Total Stock Market ETF (Broad US market exposure and rock-bottom MER. I've been convinced that hedging the CAD/USD exchange rate isn't worthwhile over the long term)
20% VEA - Vanguard Europe Pacific ETF (Since the exchange rate exposure is to a basket of currencies, buying one of the funds hedged to USD doesn't make much sense)

Specific Equity - 5% (My commissions are low enough relative to assets that they shouldn't drag even these small allocations too much)
2.5% - BHI Baker Hughes
2.5% - SII Smith International
I decided to invest a small portion in oil field service companies. Originally I was planning on investing this portion in an oil commodity fund like USL, DBO, or USO, but the problems of contango/backwardation and possible rule changes in the futures market make them unsuitable for long-term investment. I found the integrated major producers either ethically (XOM, Chevron, etc.) or financially (ConocoPhilips) unappealing, but I found some good companies in the oil field service sector. BHI, BJS, and SII are all relatively solid value stocks with good long term potential; since BHI is buying BJS, likely by the end of this year, investing in both would be redundant.

Bonds - 35%
25% XSB - iShares CDN Short Bond Index Fund (Short bonds have lower volatility than longer duration bonds, which is an important attribute for the bond portion of the portfolio)
10% XRB - iShares CDN Real Return Bond Index Fund (Having some inflation-indexed bonds seems like a good idea)

The tax strategy is relatively simple. During 2008 I'll keep most of it in a taxable account and keep my TFSA with ING for their promotional rate, but in 2009 with new purchases and possibly movement of existing assets I'll put the foreign holdings in an RRSP and use the TFSA for holding the bonds. How much of the asset base will end up inside the RRSP I'm not sure, but I'll certainly use all the TFSA room I can.

I've set up an account with questrade, since they offer by far the lower commissions: $5 on most of the trades I'll be making, up to a maximum of 10$. My signup bonus will supposedly rebate my first $50 in trades as well. Idle cash in my taxable account will likely be moved to a high-interest savings account between rebalancings.
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D
You have a well thought out asset allocation plan. Some possible suggestions...You could consider buying short term bonds yourself; a 5 year ladder of government bonds would do. However, you'll need at least $25k in bonds for a ladder. Real return bonds are a good idea. I'm not so sure about iShare RRB ETF. The last time that I looked it had a duration of nearly 16 years. If you're looking for it to provide stability to your portfolio, it may not be the way to go. With the Vanguard funds, you'll get a lower MER and better tracking than Canadian equivalents. However, you'll have to pay currency conversion charges. You'll expose yourself to estate tax. Any Vanguard distributions will be taxed as income; this includes capital gains and maybe return of capital. You'll lose the ability to get foreign tax credits on dividends from the Vanguard Europe Pacific Fund. I agree with your decision about XIC versus XIU. In a relatively small and undiversified stock market as Canada's, you don't want to limit yourself to large caps. About buying individual stocks, that is an option if one is confident about one's ability to pick stocks.
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I do not allocate assets in the way that I have read about asset allocation. My asset allocation method is very simple, yet convoluted :confused:

During bull markets I hoard cash and cash equivalents. At that point in time I am essentially 100% cash (this only happened at the start when I had nothing else).

During an asset decline my allocation moves from cash to the depressed asset. At this point in time our allocation would be some high percentage in the depressed asset and a smaller percentage in cash.

During the subsequent recovery I begin to hoard cash again. At that point in time our allocation would be in the (previously) depressed asset and cash.

This cycle continues ad nauseum so it becomes difficult to predict the asset allocation. I can say what it is at the moment, but I have no idea what it will be going forward. I do not try and maintain any percentage in any particular asset class. In otherwords, if things had turned out differently I could have been 90% in RE or 90% in stock (for example).

I also don't sell. I don't need more cash to allocate.

I had cash (from salary) in the mid-90s which was deployed into RE (needed somewhere to live and I saw another opportunity). At this point a high percentage was (obviously) in RE. Then as RE markets continued to rise and the stock market went on a tech bull run I saved my cash. The allocation became something like 50% RE.

As JDS Uniphase, Nortel and the rest of the tech sector boomed, I cherry picked out of favour (non tech) issues and put 20% in stocks, but still maintained a hefty 30% in cash.

In 2000-2002 the stock market tanked and gave me the opportunity to move the 30% of cash into stock. At that point it was probably 50% RE and 50% stock.

During the next bull run in 2002-2007 we had a lot of cash (salary, RE rental income, dividends). At that point our allocation became almost a third RE, stock and cash. Stocks tanked again in 2008-2009 so our cash is once again almost depleted and our allocation is now around 45% RE, 45% stock and 10% cash.

I never used the asset allocation strategies I've read because I can't see how so many different asset clases can be worth investing in. If I can't find any opportunities in equities, I don't want to put money into equities (at the time) just because the asset allocation methodology recommends it.

The only reason that I have been able to amass assets in such a short period of time is being fortunate enough of having 3 perfectly timed asset busts (RE in the 90s, stock in 2000-2002 and 2008-2009). Each asset bust gave me enough time (when the bulls were raging) to save up for the next bust.

Ironically, if I graduated from university in the middle of a boom (in every market) and experienced no downturns (in any market), I would not have done very well. Asset crashes are the rain, soil and fertilizer needed to grow the next batch of crops.

I am now hoarding cash (again) and hopefully fate will give me enough time to save enough cash to take advantage of the inevitable collapse of another asset class.

I know this sounds confusing, but there is a method to the madness :confused:

However, having said all that, a person should invest in a way that is in alignment with their personality and their comfort level.

PS: With regards to your posted allocation, I would only be involved with one or two low-fee index funds and I would have 0 investment in bond funds. Again, that's me.
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That is a sound plan Rickson9 and I agree with you that is probably the safer way to get the returns, then buying overvalued stocks during bull markets. I am also high in cash and will be looking sell some of my gold holdings as they have had a good run. The only thing I added a couple of weeks ago was natural gas because it hit a deep low and almost everyone was against it.

You also said, "Asset crashes are the rain, soil and fertilizer needed to grow the next batch of crops." I know you didn't mean this but the funny thing is fertilizer may be worth a look in the year ahead as farmers are staying away from it, but can't do it for long.
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scomac
dogcom said:
You also said, "Asset crashes are the rain, soil and fertilizer needed to grow the next batch of crops." I know you didn't mean this but the funny thing is fertilizer may be worth a look in the year ahead as farmers are staying away from it, but can't do it for long.
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Are you sure about that? Ever heard of organic foodstuffs? Fertilizer will get cheap again before demand picks up. The fertilizer executives have forgotten about the basic laws of supply and demand.
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D
Really, the whole idea of having an asset allocation plan is to try to move away from timing the market and replace it with a stable, long-term plan. I've been somewhat convinced that trying to pick out the bottom (or the top) is difficult enough that it's not easy money. In fact, timing like that is probably riskier.
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DuckConference said:
Really, the whole idea of having an asset allocation plan is to try to move away from timing the market and replace it with a stable, long-term plan. I've been somewhat convinced that trying to pick out the bottom (or the top) is difficult enough that it's not easy money. In fact, timing like that is probably riskier.
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I agree that timing the market is very risky and a bad idea.
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Rickson9 said:
I agree that timing the market is very risky and a bad idea.
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But your timed shifts between asset classes seem like exactly that.
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DuckConference said:
But your timed shifts between asset classes seem like exactly that.
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I didn't shift any assets and I don't time anything. I buy assets when prices are depressed. The assets are not sold. I just keep them.

When markets are booming, cash that I earn (from salary, rental income, dividends, etc) are just saved until the next crash.

My "asset allocation" mirrors the last few asset devaluations (ie real estate in the mid-late 90s, stock market in 2000-2002 and the stock market again in 2008).

I still hold everything I bought in those downturns.

What will my asset allocation look like going forward? Well that depends on what asset crashes next.

I see no reason to have a fixed asset allocation plan. It makes no sense to me to buy an asset that isn't depressed in price just because I want a certain percentage of it in my portfolio.
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Rickson9 said:
I see no reason to have a fixed asset allocation plan. It makes no sense to me to buy an asset that isn't depressed in price just because I want a certain percentage of it in my portfolio.
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But since different asset classes have different volatility, your volatility is going to be constantly changing over time, rather than being changed in a very proscribed manner via changes to asset allocation.
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steve_jay33
Rickson9 asset allocation is very interesting.
How do you determine when an asset class has crashed?
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steve_jay33 said:
Rickson9 asset allocation is very interesting.
How do you determine when an asset class has crashed?
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In general terms, if the stocks that I am researching fall to around 10x earnings and/or 2x book value. This is a generalization because, some times, when a stock is crashing, their revenue and earnings plummet, which screws up the p/e ratio.

With regards to how I determine which stocks to research, you can read that in my 'Chuong Letters' section on my web site.

For options, if a stock that I am researching falls to around 10x earnings and/or 2x book but is still above that, I will start to sell puts and hope to accumulate a position at the price I want; the premium decreases my cost basis. A significant portion of the stocks I purchased in 2009 was in this fashion.

For RE, when rent can cover my expenses (primarily maintenance, property taxes and 75% mortgage), it's generally something interesting to look at.

Lastly, I can't pick the bottom of a crash. History shows that I'm usually too early.

That pretty much sums up everything I know.
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DuckConference said:
But since different asset classes have different volatility, your volatility is going to be constantly changing over time, rather than being changed in a very proscribed manner via changes to asset allocation.
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Once I've locked an asset at a cheap price into my portfolio, I don't really care about how its price moves up and down.

As an investor, the only purpose volatility serves is to get me a cheap price. Otherwise, volatility is a non-factor for me when making investment decisions.

Most people dislike volatility, but that is a mistake. With companies that exhibit extreme volatility it is easier to make money. You don't need to be as 'accurate' when picking your buy points.

One of the reasons that it is difficult to make a decent return with Berkshire Hathaway is that it is not very volatile. Your timing actually has to be very good (impossibly good) to make a decent return and my timing is terrible to non-existant.

The example I gave was picking up Berkshire Hathaway class B shares when they fell from $2700 p sh to $1400 p sh at an average cost of $1800 p sh. As you can calculate, the return based on a $1800 p sh cost basis is not great and would be significantly better if I could buy it at $1400 p sh. However, looking back at that time, I don't see how I could possibly have bought the bulk of my shares at $1400 p sh.

One of the reasons I've made so much money with companies like Fossil or The Buckle is that they swing wildly. Once I have evaluated a company like Berkshire Hathaway, The Fossil, The Buckle, or whatever, as something I would like to own, the next 'break' for me is if the stock price swings wildly. As I mentioned with Berkshire Hathaway, a 'wild' swing is pretty narrow and doesn't happen often.

With The Fossil or The Buckle, they can go from $40 p sh to $10 p sh at the drop of a hat (despite improving or stable fundamentals). My timing doesn't need to be very good to make money - I can buy at a number of price points and make a very very good return.

"There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month." - Warren Buffett
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steve_jay33
Rickson9 said:
...
For RE, when rent can cover my expenses (primarily maintenance, property taxes and 75% mortgage), it's generally something interesting to look at.

Lastly, I can't pick the bottom of a crash. History shows that I'm usually too early.

That pretty much sums up everything I know.
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That was a nice simple explanation for a really tough topic.
I am guessing for RE you use a 10-year real estate mortgage rate, since that is more stable and realistic rate.
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steve_jay33 said:
That was a nice simple explanation for a really tough topic.
I am guessing for RE you use a 10-year real estate mortgage rate, since that is more stable and realistic rate.
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Not necessarily. I will consider a 5-year term. A 10-year term would be preferable if it works. However, I wouldn't entertain anything longer than a 25 year amort.
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steve_jay33
Rickson9 said:
Not necessarily. I will consider a 5-year term. A 10-year term would be preferable if it works. However, I wouldn't entertain anything longer than a 25 year amort.
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Interesting, I would consider 5 year terms on real estate very short term.
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steve_jay33 said:
Interesting, I would consider 5 year terms on real estate very short term.
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Depends on your amortization. For a 10 year amort, a 5 year term isn't unreasonable.
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