Dylan

I’m often asked, what do you think of my allocation or “how should I invest?” Problem is, almost everyone—advisors included—lack a sensible, practical and successful investment framework. Here’s one you can borrow: 1. The goal of investing is to earn a long-term return sufficiently above inflation to fund your goals—retirement, income, and eventually legacy. 2. The main investing building blocks are stocks, bonds, and cash. Cash for immediate needs, stocks for long-term growth, bonds for a bridge when stocks are down temporarily (only) if you’re in spending mode. 3. Realize Stock & bond markets are reasonably efficient; don’t pick stocks/managers or time the market. This will cost you 1-2%/yr in missed out on returns 4. Asset allocation (not selection & timing) drives returns, establish a mix of stocks/bonds that exceeds your goals and that you can live with. 5. General Allocation guidelines: Start with S&P 500 & 5-year T-notes. 100/0, 85/15, 75/25, and 65/35 are the most appropriate mixes. A good rule of thumb is 100% stock when saving for retirement, in retirement put 5yrs of spending in bonds. If spending 5%, 75/25. Semi retired? Maybe 85/15. Retired and more risk averse? 65/35. Retired with strong stomach and meaningful charitable/legacy goals? Stay 100/0. 6. Fine-tuning asset allocation: let’s get bond guidelines out of the way— Given their role as a portfolio stabilizer and liquidity tool, keep bonds short-term (5yrs or less) and high quality. Short-term bonds have historically had same return as long-term bonds with fraction of the volatility & inflation risk. Also Diversify to global developed markets, adjust average maturity based on shape of yield curves (extend when upwardly sloped, shorten when flat/inverted). 7. With bonds out of the way, Focus on stocks where expected return spreads are higher—Start w/F/F 3-Factor model: stocks > bonds, Small stocks outperformed large stocks and value stocks have outperformed growth stocks. Weight stocks 60/40 large to small—large cap = 50/50 growth (market)/value; small cap = 100% value. 30/30/40 is a more balanced & diversified mix with > expected returns vs market or S&P 500-only portfolios (historically 2%/yr+). 6. Add 30% international large/small value stocks overseas—higher expected returns than EAFE and better diversification to a U.S.-based portfolio. Also 60/40 large to small. 7. “Reconsider your core”: Given recent research breakthroughs on gross profitability (often mislabeled “quality”)—companies with higher gross profitability outperform the S&P 500/market index and lower profitability companies (the market holds both), big companies tend to be most profitable. Large cap high profitability stocks are a better “core” than the US market or S&P 500—higher expected returns and better diversification to a value-tilted stock portfolio. (So we’ve settled on 21/21/28/18/12 in stocks—US high profitability, large value, small value, int’l large value, int’l small value). This mix has 2-3%/yr higher expected returns vs market-based index stock allocations 8. Use DFA funds or ETFs for implementation, they offer the purest exposure to the asset classes, most experienced management, and evolve prudently to incorporate new asset pricing research findings 9. Rebalance your portfolio anytime it deviates 20% from target. In IRAs no constraints, in taxable use dividends and cashflows, then long-term capital gains. 10. Retirement income is a special form of rebalancing—sell stocks in up markets, bonds in down markets (so you better own the right ones!) 11. Stay disciplined: (a) don’t chase performance; an asset class mix WILL underperform something ALL the time (but the something will always be different), (b) don’t bail out in down markets—know the historical behavior of your asset allocation (73-74, 00-02, 08, q1/2020, 2022, etc,), and (c) resist the urge to keep adding “stuff” like alts, commodities and fringe factors. Set an extremely high bar for making changes—if you’re making more than 1-2 changes a decade you’re not doing it right. This mix has changed 3x in 30 years; 1993 add US large/small value, 1995 replaced EAFE w/int’l large/small value, and 2017 add US high prof. Staying disciplined will save you 1-2% in missed out on returns that the average investor pays due to bad timing & decision-making (see M* “Mind the Gap” studies)