by Kevin Dieker
Asset Allocation is simply a term to describe the mix of investment types you are invested in. Your asset allocation is more or less your investing blueprint, and can be tailored to your time horizon and your risk tolerance. There are different asset classes you can invest in: individual stocks, stock mutual funds, bonds, cash & cash equivalents, real estate, etc. For simplicity in this article we’ll just stick to stock mutual funds, bonds, and cash. Each asset class has its pros and cons.
Stock Mutual Funds – are made up of a basket of individual stocks that are professionally managed. Stock mutual funds offer some of the highest returns over time, but can also be very volatile and drop in value quickly – example: the rapid spring market decline due to Covid 19. Stock mutual funds are an aggressive investment. For those reasons stock mutual funds should only be invested in if you have a long time horizon. It is not wise to put your money into stock mutual funds if you plan on, say using that money for the down payment on your house next month. Examples of diverse, low fee stock mutual funds available within our Schwab Self Directed Option, SDO, are the Schwab S&P 500 Index Fund (SWPPX) and the Schwab Total Market Index Fund (SWTSX).
Bonds – can be made up of corporate or government bonds. Bonds tend to offer much lower returns than stocks over the long run. But they are much less volatile and tend to preserve their value better than stocks. Bonds are considered conservative. For that reason bonds are a good place to put some of your money that you need to live off of, say like the next few years worth of your living expenses right before you are about to retire. An example of a way to capture the entire bond market and keep fees low is the Schwab US Aggregate Bond Index Fund (SWAGX).
Cash and Cash Equivalents – are checking and savings accounts, CD’s, money market funds, and money market accounts. Within our Schwab SDO the money market sweep account is a cash account. Cash accounts are very safe. Some like checking & savings are insured by the FDIC. They earn very little, if any, growth. They are a great place to park money that you absolutely need to be there, like your emergency fund or that down payment on your house.
Asset Allocation is simply the percentage of each asset class you would like to have in your portfolio. An asset allocation of 100% stock funds is very aggressive. A 100% asset allocation of bond funds and/or cash is very conservative. You can figure out a mix of aggressive and conservative assets that creates a plan that matches your time horizon and risk tolerance. An aggressive mix would be something like 80% stocks/20% bonds, or 90% stocks/10% bonds, and may be appropriate for someone with a long time horizon and someone who isn’t going to panic sell when your portfolio has a large drop in value. A conservative mix is something like 20% stocks/80% bonds, and may be appropriate for someone that is at the tail end of their life and able to meet all of their expenses. A conservative mix is a much smoother ride with less volatility, therefore it may also be appropriate for those that lose sleep at night over large losses in value. The whole idea is to pick an asset allocation that is your plan you can confidently stick to in good times and bad. Your asset allocation may change over time as you enter new phases. For example, as you approach retirement you may want to consider a more conservative mix.
Rebalancing – As the market fluctuates over time your asset allocation will get out of proportion with your plan. Let’s say your target is 80% stocks and 20% bonds, but the market declined and the mix of your portfolio is now only 70% in stocks, but 30% bonds. You will need to rebalance. You can sell off some of what you are higher in and buy more of what you are lower in to get back to your target mix. You can rebalance once a year, or even once every 3 months, depending on how often you want to mess with it. You can also rebalance with your regular contributions (dollar cost averaging) and just buy only whatever asset you are lower in with your ongoing contributions. Regular rebalancing tends to give you better overall returns because it forces you to buy low and sell high.
Target Date Funds – are intended to be a totally hands off investment approach. They automatically adjust your asset allocation from more aggressive to more conservative as you age. Much like the clutch and gas pedal they start off heavier in stocks and lesser in bonds, and gradually reduce your stocks while increasing your bonds as you approach your target date. The automatic rebalancing and adjustment for risk is designed to be set it and forget it. If you find that the target date that they recommend for you is too conservative you can always select a target date fund that is farther in the future than the fund they recommend based on your age/retirement date.(i.e a 2060 Target Date Fund is way more aggressive than a 2030 Target Date Fund). Same thing, you can go more conservative by choosing a target date sooner than the recommended fund based on your age/retirement date. Target date funds in the SDO can be very low fee (ex: Schwab Target Date Index Funds). NOTE: choose the Schwab Target Date Index Fund version for the lowest fees.
PERS IAP Member Choice Coming September
Currently PERS automatically invests your IAP money for you in a Target Date Fund they have chosen for you based on your age. A heads up that during September 1-30, 2020 PERS is allowing you to have some limited control of how your IAP is invested. They will allow you to choose between the Target Date Funds they offer. If you would like to have a more aggressive asset allocation within your IAP you can choose a Target Date Fund with a later target date. Example: a 2060 fund is more aggressive than a 2030 fund. (The IAP 2060 Target Date Fund mix is approx 85% aggressive investments, 15% conservative bonds & cash). By the same token you can choose a sooner Target Date Fund if you would like a more conservative asset allocation within your IAP. The selection will take effect on Jan 1, 2021. Info on the IAP Target Date Choices
The F.I.R.E. 