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Asset allocation

Investment discussion for beginners. Why you should invest your money, get help getting started
funduffer
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Asset allocation

#415867

Postby funduffer » May 28th, 2021, 3:32 pm

Conventional investing wisdom says that you should diversify your wealth through asset allocation - i.e. between equities, bonds, cash, property and physical assets (Eg gold etc). This is to protect your wealth during various shocks to the system (E.g. stock market crash, recession, inflation).

But what is my asset allocation? Should I just look at my savings and investments, or take into account my pension and my house?

For background, I am retired and in receipt of a pension, I have reasonably significant savings and investments and I own my own house.

If I just look at my savings and investments, my asset allocation is:

62% Equities, 23% Cash, 11% Bonds, 2% Property, 2% Other
(Cash is high at the moment, as I have just been in receipt of a legacy. Normally, I would aim for 80-90% equities)

If I assume my (DB) pension is invested in bonds (which my pension provider seems to indicate in their literature), and is worth 25x my annual pension, then my asset allocation becomes:

65% Bonds, 24% Equities, 9% Cash, 1% Property, 1% Other

If I add in the value of my house, my asset allocation becomes:

56% Bonds, 19% Equities, 18% Property, 7% Cash, 0% Other

Massively different results, so very difficult to judge if the asset allocation is 'right' or not!
This is not something I lose sleep over, but it is something that puzzles me when I read articles about asset allocation, re-balancing and adjusting the allocation as you get older.

Any views?

FD

1nvest
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Re: Asset allocation

#415962

Postby 1nvest » May 29th, 2021, 12:12 am

100% bonds.

You can consider different assets as different forms of 'bonds'. A house is like a bond where shelter is the coupon. Stocks are a undated variable coupon bond. Gold is like a undated zero coupon currency unhedged global bond. 50/50 stock/gold barbell combines to a central (volatile) global bond bullet ...etc.

The trick is to diversify rather than concentrate. Long dated gilts might broadly compare in total return to a 10 year bond bullet over a full cycle, but will zigzag around the 'total bond' middle road choice.

How much in each is perhaps less relevant than not too much in any one choice (concentration risk). And also costs/tax efficiencies/risks. Inflation bonds for instance have income taxed, so if interest spikes due to high inflation, then likely so also will taxes have spiked. 20% inflation, 20% interest, 50% tax, -10% net real.

Example of different 'bonds'.

The thing about increased bonds near/in retirement is more often to reduce risk. Need £10K/year for 20 years anticipated remainder life expectancy in addition to occupational and state pensions, anticipate 2%/year inflation, so stick £243,000 under the mattress to provide that guaranteed £10K/year 2% inflated 'income'.

In your case it looks fine, not too much in any one 'bond' (the third does suggest too much in 'bonds' but that's combined pensions and bonds ... which should be considered separately). Wall Street Crash type situation where stocks lost -85% (-75% in real total return terms); Occupational pension fails/defaults; If there's a war and your house is destroyed/confiscated without insurance cover ...etc. and you're not all-in on one asset, avoided 'failure' due to too much concentration risk.

When considered as being 'bonds' you might apply relative valuations as a means to determine what weightings of each you might want to hold at any one time. When Index Linked Gilts were paying north of +4% real yields; When a ounce of gold bought the Dow index (Dow/Gold ratio near 1.0) ...etc. Or avoid/reduce bonds that look relatively over-priced, long dated gilts at present for instance. Defer buying a house if the house/gold ratio suggests prices are high; Reducing stock when the Dow/Gold ratio looks high ..etc.

Shop for assets as you would shop for groceries. Many do the complete opposite and will buy more of x when prices have soared.

JohnW
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Re: Asset allocation

#415972

Postby JohnW » May 29th, 2021, 6:31 am

Always good to have a different perspective, like viewing other assets in bond terms; you can feel a ‘but’ coming though…
A bond is a contract to pay periodic interest and return all capital. That’s not how equities work by a long shot, with no obligation to return your capital or pay interest.
A house can collapse under you into rubble or just slowly rot away, unlike a bond.
The perspective is interesting but I’m not sure it helps when thinking about your financial affairs. And you'd certainly have to do a lot of adjusting when you hear others talk of a 60/40 portfolio.
There’s a view, unvalidated simply because I share it, but reasonable I think, that your house is your shelter and thus too important to be considered an investment and put at risk like investments. Is there some way it helps to view it as an investment asset, that counters the reality that you have to sleep somewhere, that isn't addressed below? Yes, it’s an asset, but beyond that….?
A (DB) pension is like a bond except that you can’t sell it, and it has no redemption value and no maturity date and might provide reversionary benefits; so it’s not like a bond really.
The prevailing view, I think, is that the easiest way to view your investment assets with regard to their correct allocation, is to ignore the house and the DB pensions, then consider your equities, bonds, cash and other real estate as your investment assets such that their mix is appropriate for your circumstances (accumulation, retirement, risk tolerance). And if you’re close to retirement, match those assets with your spending requirements which go beyond your assured pension income and rental income.

Dod101
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Re: Asset allocation

#415980

Postby Dod101 » May 29th, 2021, 7:23 am

I do not buy into 1nvest's argument and in any case I assume that the OP is concerned about asset allocation of his investment assets. He should thus set aside his house and possibly his DB pension but if he were to allocate that then I would certainly assign it the category of a Bond as long as it remains in the custody of the pension scheme trustees. If he were ever to take the cash value then that would change how he should look at it.

If I were him I would simply take his savings and investments and leave it at that. His main dilemma is what to do with his cash allocation which is too high now surely, with inflation possibly on the horizon. With the security of the DB pension in the background, he can surely afford to have his previous allocation of 80/90% in equities with the rest mostly in cash/bonds. I have more or less done that for the last 25 years since retiring, without a DB pension and on the whole, it has worked fine.

Dod

funduffer
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Re: Asset allocation

#416123

Postby funduffer » May 29th, 2021, 7:52 pm

Thanks Dod, that sounds like sound advice.

LooseCannon101
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Re: Asset allocation

#416124

Postby LooseCannon101 » May 29th, 2021, 8:02 pm

My asset allocation is 99% highly diversified world equity portfolio and 1% cash. I treat this as a business.

I do not consider pensions and my home to be investments. Nice to have, but not part of 'the business'.

Allocating smaller amounts of capital to equities as one gets older, is not recommended by Benjamin Graham (Warren Buffett's mentor). If the average total return is 8%, why move into cash?

scrumpyjack
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Re: Asset allocation

#416125

Postby scrumpyjack » May 29th, 2021, 8:08 pm

Unless the bonds are index linked they are a huge gamble on future inflation. What matters in 25 years time is the purchasing power of your pension fund, not its nominal value. So having been a young man in the '70s when inflation hit 27% at one point, and having seen some of my grandparents generation put most into War Loan, resulting in a near total loss of purchasing power, I am very mindful of how risky bonds are. It is just a different type of risk compared to equities, which generally represent a share of ownership of real economic activity, whilst bonds certainty is only in nominal terms.

But you have to do what you are comfortable with.


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