Asset allocation for 2013 with low interest rates

[madmax]

I'm 27 with a fairly stable career and my wife has a stable job as well so I can afford to take some risk. I currently have about 75k in Vanguard's target retirement 50 fund (VFIFX) which has the following holdings as of today:

Vanguard Total Stock Mkt Idx Inv    63.14%    
Vanguard Total Intl Stock Index Inv    26.82%    
Vanguard Total Bond Market II Idx Inv    10.03%     

I've been reading the Boglehead wiki as well as some of the classic investment books (Random Walk, Intelligent Investor) and have been debating whether to take a more hands on approach to my investing by managing my own asset allocation.

My dilemma is two-fold:

1) What should my equity % be? Benjamin Graham suggested in his book that investors never be more than 75% in stocks. Also Mr Bogle recommends "Age in Bonds" as a rule of thumb. VFIFX is 10% in bonds and a lot of people are 100% in stocks because of unattractive bond yields.

2) Should I even be in bonds considering that interest rates are at an all time low and when they inevitably go up, bond funds will lose value. I've read on Bogleheads that in a hypothetical future where the interest rates go up, bond funds will go down because they will be holding bonds that pay lower rates - but as the bonds mature, they will be swapped for ones that pay higher rates and the bond fund will recover any lost value in the long run. Some people however, recommend TIPS and CDs instead of Bond funds at this time.


I was wondering - what are my fellow Mustachians are doing for their Asset Allocation?

[daverobev]

IMHO the whole point of this is to make sure you're saving *at all*.

I don't know what this fund's target is, but right now it looks pretty good for you. I mean, sure, there's an emphasis on your domestic market but much of that is international anyway.

IF you can be bothered to be more hands on, maybe look at 4-5 funds total: US, VXUS (which is roughly 60% developed/40% developing), bonds OR high interest savings, REITs, perhaps some additional emphasis on small cap. Do you own a house? If so that's a large chunk of your wealth in one asset, let alone one asset class, so that is diversification too.

But honestly? Don't fret. You might not be 100% optimal but it's pretty good.

[fiveoclockshadow]

Age in bonds is a gross simplification that few follow.  Bogle, despite his age, says he holds a 50/50 profile.  Target retirement funds are usually different from age in bonds.  There is a recent thread on Bogleheads about this:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=120156

And Vanguard has a paper discussing this:

https://institutional.vanguard.com/iam/pdf/ICRTDF_2010.pdf

A number of authors (e.g. Bernstein, Swedroe) point out that for young people their human capital - i.e. future earnings - are huge and "bond like" hence very high stock allocation is fine and even desirable.  Once in draw down things are more complicated but you don't need to worry about that right now.

So don't worry about having a low bond allocation given your age and earnings stability.

As to the concern that interest rates will rise and bond funds will drop this is common fallacy these days.  When a bond fund "falls" it barely falls at all compared to equities.  While interest rates will likely go up it is also very likely stocks will crash badly.  Having bonds that have dropped say 5% when equities have tanked by 50% will still allow you to rebalance into the equity dip and get nice gains going forward.  Bonds reduce volatility, and they do so even when they are slowly declining.  Another good Vanguard paper on this subject:

https://personal.vanguard.com/pdf/s807.pdf

And I'd echo daverobev's point too.  Right now your goal is to save like mad and you've got a sensible allocation right now.  If you'd like to learn and optimize some more by all means do so, but don't feel a big obligation to fine tune things.

[madmax]

Thank you for replying and for the links to Vanguard.

A number of authors (e.g. Bernstein, Swedroe) point out that for young people their human capital - i.e. future earnings - are huge and "bond like" hence very high stock allocation is fine and even desirable.  Once in draw down things are more complicated but you don't need to worry about that right now.

That is a very interesting point - I've never thought about my future earnings in that context before. The more I think about it - the more it makes sense.

After posting, I read through some of your other posts on the forums regarding bonds as well and they are all every educational. I was also fretting about changing my "Total Bond Market" fund to "Intermediate Bond market" and realized that the average duration in my TBM fund is comparable to "Intermediate". So I'm going to follow the advice given by both of you and stick the course and continue investing in VFIFX for the considerable future.

Thanks again - I really appreciate the advice.