- Warren Buffet once said, "For investors as a whole
"returns decrease as motion increases."
In other words, the more you are fiddling
with your portfolio and trading in and out
of different investments,
the less money you are going to make.
For a lot of areas in life,
the statement of, "don't just stand there do something"
is great advice,
but according to legendary Jack Bogle, the way
to wealth with investing is by doing the opposite.
Don't do something.
Just stand there.
To be able to just stand there and not do anything,
you need to feel comfortable and confident
about what you are investing in
and how much you have invested into each holding.
I'll show you how to allocate your money
in a way that'll give you a better chance
of buying and holding for the long term.
What we are basically talking about
when it comes to how much is your asset allocation.
This is a predetermined plan
for what percentage of your money you want spread
across different asset classes.
Think stock-based funds, bonds, cash, commodities,
real estate and things like that.
How you have your money allocated
across those different investments is important
because it's going to determine your returns,
how much work you have to do
and what to do with the next dollar that you invest.
Now, while everyone in theory wants to get
the highest returns possible
it is not always worth chasing.
There is no free lunch,
so if you want to chase those higher returns,
then you have to take on additional levels of risk.
Successful investing
over the long term is 50% math and 50% behavior.
This means that you are going to want to find a nice balance
between risk and return.
It's not about what's possible, it's about what's probable.
It's possible for you to win the lottery,
but it's not very probable.
The same goes for investing in the stock market.
Unfortunately, all we hear about
are the people who have 10 Xed their money
in a very short period of time,
so we assume that it's possible
for us to do the same thing in a very simple way.
The truth is that everyone loves to talk about their wins
but you very rarely hear about the losses
from taking on too much risk,
which is a whole heck of a lot more common.
You didn't hear from the five people that I talked
to who combined lost more
than $200,000 following stock picking YouTube channels.
You definitely need to accept some level of risk
with investing or else your money is never going to grow
which will put your future self
in a very horrible position when it comes to retirement.
The first important part when determining your
asset allocation is figuring out the level
of risk you are willing to take.
Your risk level will be obvious based on the stock and bond
and mix that you hold.
To simplify the two sides of the coin,
allocating money to stock related funds
assumes a higher level of risk
with a higher potential return because at a basic level,
you are investing in the future success of those companies
which isn't always guaranteed.
Allocating money into bonds assumes a lower level of risk
with a lower expected return because they are
guaranteeing you a specific payment ahead of time.
When you combine stocks and bonds together,
you get diversification from a risk return perspective
because both asset classes aren't highly correlated.
Using a stock and bond strategy helps to minimize the risk
of losses because when one asset is declining in value,
others in the portfolio may
either be increasing in value or not declining as much.
In reality, it's extremely difficult to find two
asset classes that are 100% uncorrelated 100% of the time.
Now, this isn't a reason to admit defeat when it comes
to diversification, but it is something to be aware of.
For example, you'd think that stocks
and bonds were 100% uncorrelated, but over the past couple
of years when stocks have fallen, so have bonds.
While this is true, bonds haven't dropped in value
at the exact same rate, so they've technically
still given the investor a level of protection.
Here's the same chart I just showed you
but I added some diversification.
A portfolio with an allocation of 80% stocks and 20% bonds.
The drawdowns aren't as extreme as a 100% stock allocation,
but they're not as stable as a 100% bond allocation.
When we diversify and adjust for risk,
the returns for something like an 80/20 portfolio
is better than 100% stocks.
Diversification isn't just important when it comes
to the stock and bond mix.
It's also important when we dig deeper into the types
of stocks and bonds that you hold as well.
With stocks, diversifying in companies outside
of your home country is something to think about.
While a lot of US-based companies
make money outside of the country,
that's not always enough to be fully diversified
across the world.
So when it comes to diversification,
these are the main things that you need to know.
Number one, everything is going to be
at least a little correlated.
Number two, there are going to be short periods
of time where assets seem to be correlated,
but over the long term that correlation is reduced.
Diversification reduces risk and increases returns
over long periods of time.
By returns, I am referring to risk-adjusted returns.
And number four, diversification is
for people who are playing the long game and not
looking to play the get rich quick game in the stock market.
The third important aspect
of asset allocation is rebalancing.
An occasional adjustment to your portfolio
will make sure the allocation
of your assets stays relatively close
to the target percentages that you set in advance.
There's two ways this can be done.
Number one, through regular contributions if you are
in the accumulation phase of invest and/or number two,
by selling off over-performing investments to
purchase the underperforming investments so
that you can get back to your target allocation.
If you are going with number two, then a once
per year rebalance is more than enough.
I personally wouldn't say to do it any more than that.
There's three big reasons why rebalancing is so important.
Number one, because it increases long-term returns
while reducing risk.
Number two, if you don't rebalance, then you'll most likely
end up with an all stock portfolio since the expected
returns on those is higher than bonds.
And number three, if you hold a US
and international stock fund,
then over time one will naturally outperform the other.
- By not rebalancing back to the target allocation,
you might be reducing your overall diversification.
Before I tell you about the biggest myth
with how you invest your money,
please help support my little dog, Molly
and the free content on this channel
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I'm going to give you some example portfolios
but first I need to call out one very important thing
when it comes to choosing the best asset allocation.
There is no magical perfect way to spread your money
across all of the funds that you invest in.
Don't feel bad about that though because no one can do this
since we cannot predict the future.
We can only determine what the best portfolio
was when we look back into the past.
Here's a quick snapshot of how different asset
classes have performed over the past few years.
Trying to predict what will perform well
or basing your decision
on previous year's winners is a loser's game.
Your job as an investor is to find an allocation
that will do reasonably well
under a wide range of circumstances
and the way to do that is to buy
and hold a globally diversified portfolio
so that you can benefit from anything
and everything that happens to do well that year.
Behaviorally, it's also going to be important to
pick an asset allocation that you can 100% stick
to during the good and bad times.
That's way more important than trying to find
the tooth fairy of allocations with the highest returns.
You're better off building an okay portfolio
with reasonable returns that you'll stick
to versus the perfect portfolio
with super high expected returns that you won't
because you've added way more risk
than you can handle.
Over short periods of time,
your stock allocation matters a whole heck of a lot
but for us long-term investors,
it's less important to get the percentages dialed in
perfectly.
All right, so I'm going to give you a few different
portfolio options when it comes to asset allocation
going from a very simple approach
to a more complicated approach.
First, if you just want a completely hands off approach,
then you can go with either a target date fund
or a life strategy fund from Vanguard where
they've already chosen the allocation mix for you.
Pro tip, don't hold these types of funds
in taxable investment accounts, only tax advantage accounts.
The next level is going to be to build something
like a two or three fund portfolio.
Either of these portfolios will work
for someone who is in the accumulation phase of investing.
To be transparent, I'm biased
towards the two fund portfolio right now
and will eventually switch to the three fund portfolio
when I get closer to retirement.
You'll hear a lot of people, including myself,
say that young people holding bonds
doesn't really make sense.
Since that is the perfect time to bear as much risk
as possible for the highest potential return possible.
But if behaviorally you don't think
that you can handle the wild swings that come
with a 100% stock-based portfolio, then don't feel bad
about going with a three fund portfolio where you allocate
at least a little bit of money towards bonds.
As I'll continue to repeat,
you want to build a portfolio from the very start
that you can stick to through thick and thin.
The next example portfolio is
from a book called the "Intelligent Asset Allocator."
I highly recommend it if you want to nerd out
and go a little bit deeper into asset allocation.
As you can see, it gives you a little bit
of everything split up into individual funds.
The author calls this his level one portfolio
since it's pretty simple and easy to manage.
Not as simple as the two or three fund portfolios,
but it's the next step up from them.
The level two portfolio the author mentions
breaks his first portfolio
down into even more specific slices.
Keep in mind that the more funds you choose to add,
the more work you have to do.
Do not choose this type of portfolio
if you are not willing to manage it.
Here's the author's comments about the level two portfolio.
This portfolio is for the individual who is serious
about diversification and wants its full benefits.
You may wish to add other asset classes as well
such as precious metals, stocks, and international bonds.
Adding more funds beyond what he has listed
in the second portfolio is what he calls level three.
I agree with his comment in the book
about the fact that this portfolio is only
for people who truly enjoys investing and who has the time
and patience to deal with the complexity.
In that same book I just mentioned,
the author gives a good rule of thumb chart
that I'll put on screen.
Now, it might help you decide
for yourself how you want to allocate your money.
Vanguard also has a helpful chart to show you how
different portfolios have performed in the past.
I'm not a big fan of using past performance when it comes
to choosing an asset allocation,
so I'd recommend using this chart to focus more
on the worst annual gain section.
Go through each one and ask yourself, if I held each
of these allocations, then could I handle this type
of decline based on my risk tolerance
and how long until I needed this money to live off of?
If you had $1 million or five years from retirement
and held a 100% stock portfolio,
could you handle that type of decline?
Your $1 million would turn into $570,000
which would be devastating to you being able to recover
in time to actually retire in five years.
A person who has more than 20 years
until retirement can handle a large decline
like that because A, they have more time to recover,
and B, they'll most likely continue investing more money
at lower prices.
When it comes to how much to allocate
to international stock holdings,
I've seen recommendations from experts range
from 15 to 25% during the accumulation phase of investing.
As you enter retirement,
I've seen some experts suggest a dropping down to 15%
then back down to 10% at some point
during retirement as allocations shift more towards bonds.
These are only guidelines though, so remember that.
You need to pick an allocation
that you feel comfortable with.
Like I mentioned earlier,
it's impossible to pick the perfect allocation
so as long as you get it close enough, you are good to go.
If you pick a certain allocation
then realize that it doesn't work for you
then don't be afraid to change it,
but you should not be taking cues as
to what to do with your portfolio from outside influences
like the stock market, the economy, or political events.
It should only be adjusted based on your risk tolerance.
Trust the process, ignore the noise, and continue investing.
When you think about how you want your money allocated
you'll want to think about it in terms of all
of your investments combined across all of your accounts.
The problem is that this can be extremely difficult to do.
The reality is that most of us have accumulated
more accounts than I have ex-girlfriends.
Multiple 401ks from different employers,
Roth IRAs, HSAs, 457s, 403Bs,
and taxable investment accounts.
Because of that, there's money everywhere
and all kinds of different funds.
That's why I created a little target allocation
tracking spreadsheet that I'll share with you for free.
It'll help give you a bird's eye view
across all your accounts so that you can figure
out where your asset allocation currently is
and where it needs adjusted to get
to the targets that you want.
I'll have a link in the description to send you a free copy
of this spreadsheet as well
as a private video where I walk you through
more details on updating this file as time goes on.
Hit that thumbs up button and share the video
with someone you think needs to see it.
Ways to help support this free content
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I'll see you in the next one, friends.
Done.