DIY Asset Allocation

Having been a couple for 39 years, my spouse and I have accumulated a variety of different types of investments and accounts over the years. Each year, I review the status of our accounts against our target allocation and then try to devise a plan to re-allocate as needed. Since I am also dealing with a lump sum distribution from a retirement account this year, I have been thinking a lot more about asset allocation.

Because of my recent focus on allocations, I decided to share the process I use along with some of my challenges with DIY asset allocation with you.

Do It Yourself Asset Allocation

Step one: Figure out the current actual allocation for all of our invest-able assets.
You would think that would be fairly simple, right? Just classify the asset, add the current market value to the total for that classification, then divide the final total by the total amount of invest-able assets to get the percent allocated to that classification. For instance, if we have 3 bank accounts and a CD, I add the current value of the bank accounts and the current value of the CD. Lets say that total is $50,000. Then I divide that amount by our total invest-able amount. Lets say that is $1,500,000. So my percent actually allocated to cash is 3.33%

But, how do I find out what the split is for each mutual fund? How much of our fund is cash, how much is international stock, how much in domestic large cap stock and etc? Finding a website that splits this out is not always easy, and is always time consuming. So much so that I typically don’t bother – I just take the fund objective and call it based on that – not very precise!

What classifications should I use? Should it be by stocks (large, mid, small cap, international, global, etc); bonds (corporate, junk, short term, intermediate term, long term, domestic, foreign); and cash (do I include annuities that could easily be cashed, money market mutual funds or just bank accounts and CDs); or should I classify by market segment – healthcare, commodities, energy, utilities, railroads and etc?

My favorite classification categories are Stocks – including mutual funds (large, mid & small, and international); Bonds – including mutual funds; and Cash – including anything that is fixed in value such as money market funds or annuities that can be cashed out without loss.

Step two: Set our target allocation.
Again, that sounds pretty simple but it can get complicated.

Setting the targets has always been kind of a stab in the dark for me. Sure, I studied what the broker or financial planner recommended, read various books by investment pros and thought through what we wanted to accomplish. But actually putting pencil to paper and coming up with a percent that accounts for a) our goals b) our tax situation and c) the economic outlook for the year has always been high level guess work for me.

To complicate things, my spouse and I have different risk tolerances. He is more risk averse than I. So we tend to compromise. Our current allocation targets ended up as:

Cash 5%
Bonds 30%
Stocks 65% overall divided up as 30% large cap, 15% mid and small cap and 20% international (up from 15 from last year due to the economic situation).

Our broker and a financial planner I consulted both recommended that (due to our august ages), we should be 60% fixed income and 40% stocks, however, for us there are circumstances that we feel allow us to be a bit more adventurous. For example, we have more than adequate income without using any principal or income from our investments, and so feel we don’t need as much income from investments.

Step three: Figure the difference between what our allocation is and the target.
This part actually IS pretty easy. It is just math. I subtract the target amount from the allocated amount to see if we need to add or subtract to that classification. In the example above, we had $50K cash and $1.5 million total, so our target at 5% should be $75,000. We should add $25,000 to our cash position.

Step four: Come up with an action plan for the year to get to our target allocations.
Considerations include:
Should I try to keep each account we have at the target allocation, or do the allocation across all accounts?

We have two brokerage accounts and multiple mutual fund accounts along with several bank accounts. Some of the funds are in Roth IRA’s, others are in a traditional IRA that will have required minimum distributions (RMD) in 8 years.

Although it seems simpler to me for each account to have the same target allocation, that doesn’t always make sense. It doesn’t seem as practical to put more risky investments into the traditional IRA – as we might have a loss when I have to draw them (due to RMD). The Roth IRAs are meant for the grandchildren, so the investment horizon is longer. These seem more appropriate for the more risky investments, as they would have time to recover if a downturn occurred.

Should I try to keep each of our trusts at the same target allocation (even though we have different risk tolerances)?

The trust accounts are designed to lessen estate taxes on our death and make use of each of our estate tax exclusion. To have exactly the same allocation might require that we have mirror accounts at each institution, one in my trust and the other in my spouse’s trust. Sometimes this adds to account charges.

Should we sell assets that are over allocated and invest in ones where we are under allocated?

This is the recommend thing to do. It theoretically allows you to sell high – cashing in on assets that have done well (and grown into an over allocated situation) and buy low – getting assets that have lost value at a better price.

For several years, due to our tax situation, we have been using ‘new’ money to try to adjust the allocation – buying into only the classifications where our targets are low. This allowed us to NOT take a tax hit on the sale of the assets in the over allocated classifications.

Should we invest in mutual funds, exchange traded funds (ETF) or direct assets?

We are more buy and hold investors so we typically choose mutual funds over ETFs. For domestic large cap companies we prefer direct shares – it eliminates the overhead of the management fees.

Should we put more money into existing companies or funds or diversify and get others?

When we feel overwhelmed by the number of accounts, we tend to put the money into existing ones (or even consolidate multiple existing account assets into one). When we feel vulnerable or see an investment we really like we tend to diversify into different funds or companies.

How do our wishes for real estate assets fit into the picture?

To be honest, we are still struggling with this one. Should there be a non primary home real estate component in our mix? If so, what should it be – actual property, REITS or something else?

Which investments should go in taxable vs tax deferred vs tax exempt accounts?

This used to be a no-brainer when we both worked, the answer was tax exempt when possible, tax deferred if not tax exempt and taxable as a last resort. Now that we are retired, the answer may get more complex – depending on our tax status each year and the amount of the return for the investment.

Step five: Present the re-allocation plan to my spouse.
We review it, talk through it and compromise until we agree with the action plan.

Step six: Implement the plan.
This has turned out to be a year long task for us, sometimes even a multiple year task. It takes persistence to carry through on the research, the review and the purchase or sale to get to our allocation. Some years we make it, others we don’t. Why you ask? Life gets busy and we (unfortunately) sometimes allow less important tasks to take up our time. Occasionally, the economic situation changes and we hesitate to implement our plans. At other times, we see our current investments doing well and want to run with them.

What would make this easier?
We could hire a money manager.
For us, this is not a desirable alternative. We don’t believe that money managers (who charge a percent of assets under management) provide enough value for the price. We have seen ‘money managers’ stick people’s money into a target allocation fund and not do anything else with it – and for that they get paid 5% of the total money each year!

We could invest in mutual funds that automatically re-allocate.
For us, this is not a desirable alternative either. We like the flexibility of controlling the flow of our own funds, as opposed to letting a computer program do it.

I’d be interested in hearing your experiences and thoughts on asset allocation.