This is a look at the eighth chapter of The Bogleheads’ Guide to Investing, by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf. This chapter focuses on asset allocation, the “most important portfolio decision.”
The authors start by reviewing empirical research from the 20th century, including the studies that resulted in the development of Efficient Market Theory and Modern Portfolio Theory. The academic studies lead to the realization that most of which Wall Street sells is overpriced, index funds provide higher returns with less risk than managed funds, and there is no way to “beat the market” despite all Wall Street’s promises. Academics do not have the money to advertise, and thus their opinions aren’t popularized.
Most of a portfolio’s long term performance depends on the focus on a “strategic asset allocation policy.” One of these policies can be developed by evaluating an individual’s answers to four questions:
* What are your goals?
* What are your time frames?
* What is your risk tolerance?
* What is your personal financial situation?
Answers to these questions allow the investor to decide how to allocate his or her funds between various sock types (large cap, small cap, value, growth, international, and others like REITs) and various bond types (short-term, high-yield, inflation-protected, etc.).
The authors also provide eight different model portfolios for four different categories of investor (young, middle-aged, early retirement, and late retirement) with a focus on low-cost index funds from Vanguard.
The chapter is fairly short and manages to lightly touch the important aspects of asset allocation. An entire book can be written on the topic, though I’m sure only a few would be interested in reading it. The chapter covers the basics and is enough to inspire someone to evaluate their own asset allocation, as I did last night. Hopefully the taste of the chapter I provided whets your appetite for the entire chapter, which is unsurprisingly available within the book.
And now for this week’s giveaway! Here’s a discussion question for you to respond below (or just write any comment you feel like). How much thought have you put into your asset allocation strategy and how did you decide upon your choice? For example, did you use a certain “rule of thumb” that dictates your percentage of bonds should be your age?
A random winner will receive a copy (my copy) of The Bogleheads’ Guide to Investing and another copy of Elliott Wave Principle: Key to Market Behavior, by A.J. Frost. Both books are hardcover and in perfect condition. By the way, if you’re a “long time reader, first time commenter,” say so, and you’ll get two entries in the contest for the “price” of one.
Updated February 6, 2012 and originally published October 11, 2006.