The primary driver of portfolio performance is asset allocation – how much money you have in each type of investment in relation to the other. To be more specific, 91.5% of your portfolio’s performance comes from Asset Allocation, when compared to Security Selection (4.6%), Market Timing (1.85), and other factors (2.1%)*. With so much riding on what is invested where, it is important to set an overall decision on how much money you would like to have invested in stocks (where the money may be made), and bonds (where money may be “safer”).
There are many different ways to decide how much money to invest in stocks and how much to keep in perceived “safer” investments. One way would be to determine your risk tolerance. But what if your risk tolerance doesn’t allow you to achieve your retirement goals? At Rodgers and Associates we determine what asset allocation a client needs by answering a few important questions:
- How much income will the client need at retirement?
- How much would they like to leave at their passing?
- When will they need this money?, and last (but not least)
- How much can they save?
From the answers to these questions it becomes simple algebra: Based on what a client is saving, what rate of return needs to be achieved to reach their retirement income goal? Once we know that number, we can determine the minimum amount of risk a client could take to achieve their goals. For example, if the client needs an 8% rate of return, the lowest asset allocation that we would recommend is 60% in stocks and 40% in bonds. Our recommendations are based on the 20 year annualized return for that portfolio, which is 8.5%**. If we invest in anything with a lower stock percentage than that, the client runs the risk of not achieving their goals, noting that all investments come with risk of loss, including loss of principal.
Rodgers and Associates’ strategy for stock-to-bond asset allocation is to reach our clients’ goals by taking the least amount of risk possible, creating a more tolerable and (hopefully), enjoyable investing experience.
* SOURCE: Beebower Brinson and Hood. Determinants of Portfolio Performance, 1991.
** SOURCE: DFA Matrix Book, 2013