My Asset Allocation (though it doesn’t really matter much in the long run)

Like many personal finance DIYers, I’ve invested a lot of time and energy into the search for the “optimal” asset allocation. I actually enjoy learning about this stuff so I don’t consider it wasted effort, but if you want to save yourself time here is my conclusion: As long as your portfolio is well-diversified and you stick with it consistently, your specific asset allocation isn’t going to make a big difference in the long-run.

Investment writer Meb Faber looked at 9 different asset allocation strategies that have been advocated by various experts and modeled them out over 30+ years. The net net? Returns were all within 200bp of each other (8.88%-10.49% CAGR). So…you can kill yourself trying to figure out what specific percentage you should be allocating to emerging market stocks vs. small-cap value domestic stocks, or you can just pick an allocation that is diversified enough across non-correlated asset classes (e.g. stocks vs bonds) and simple enough for you to follow-through in long-run.

After all, your wealth is a function of 1) Time, 2) Return, and 3) Your contributions (e.g. savings rate). You can’t turn back time, so the only thing you can do is start building wealth NOW regardless of your age. And as long as you have some kind of asset allocation strategy, your long-run return will likely fall within a percentage point or two no matter what you do. So focus your energy on the one thing you have 100% control over: Juicing up your savings contributions, either by cutting expenses or increasing your income. 

That said, I spent some time comparing my asset allocation with the recommendations of “experts.” My AA (which I’ve stuck with more or less for past 3 years) is based largely on William Bernstein’s The Investor’s Manifesto. For comparison, I looked at a few portfolios as generated by investment advisors based on input of my personal circumstances, plus a few non-personalized “lazy” portfolios that are designed to perform well across all market conditions.

ModelMinority’s Asset Allocation Comparison

Screenshot 2016-01-26 12.11.04

Admittedly my AA is probably more complicated than it needs to be, but I try my best to keep the number of funds down to bare minimum and it’s not difficult to keep up with after the initial set-up. Comparing across the other AAs, I notice that the personalized portfolios seem to recommend a higher allocation to equity, particularly in foreign equity. But otherwise, they don’t seem wildly different.

My AA feels roughly down the middle of the line, and I feel pretty good about it. The one area where I diverge is my 10% allocation to P2P lending, which I do through the biggest player in P2P, Lending Club. 10% is not an insignificant allocation to be putting into a financial instrument as new and risky as P2P lending, but at a median return of ~7% I’m rolling the dice.

There are plenty of downsides to P2P that naysayers will point to (e.g. your returns may be much lower due to higher-than-expected default, your money is locked up for 3-5 years, it’s time-consuming to pick the right notes), but to me the biggest risk is that like all startups, Lending Club may go bust. However, Lending Club does have a backup plan in place to have another entity pickup servicing of the loans in case of bankruptcy, and unlike other startups they have actually started breaking even as of Q3’15.

In my eyes, I’d be lucky to get a ~7% return in the equity markets and that’s laden with risk as well. So, I’m willing to take a chance with P2P, which also has benefit of further diversifying my portfolio since P2P has low correlation with stocks.

I have some work to do to get my actual money in line with my ideal asset allocation. Right now, I’m well over in equity and under in bond due to the fact that a lot of my money is locked up in my employer stock. I’ll sell over the year and reallocate to get my AA back in order.

But going back to the beginning, all of this doesn’t really make a big difference in the long-run. So…I’ll stop and go take the dog to play ball on the beach now.

Dog on beach

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