Calling All Boomers -- Poor Asset Allocation Could Be Costing You Big
03/03/2011 0 comments
There is a serious crisis highlighted by national and international media that upcoming retirees don't have the savings they will need. Their plans have been blighted by the recent financial melt-down and they are left with a hole that they have to fill somehow.
In a study of over 800 mainly retirement plans, we noted that the majority of plans supported only three asset classes which is going to have a significant impact on the potential returns for the participant.
| Asset Classes | Number of plans |
| Three | 463 |
| Four | 181 |
| Five | 109 |
| Six | 30 |
To make this clear, we are going to use a simple benchmark vehicle -- SIB -- simpler is better to show the potential difference in returns between the portfolios with different numbers of asset classes.
Each of the SIBs are built from one ETF per asset class. The ETFs we selected for these portfolios are as follows:
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE BLEND | VTI | Vanguard Total Stock Market ETF |
| Foreign Large Blend | VEU | Vanguard FTSE All-World ex-US ETF |
| DIVERSIFIED EMERGING MKTS | VWO | Vanguard Emerging Markets Stock ETF |
| REAL ESTATE | VNQ | Vanguard REIT Index ETF |
| COMMODITIES BROAD BASKET | DBC | PowerShares DB Commodity Idx Trking Fund |
| Intermediate-Term Bond | BND | Vanguard Total Bond Market ETF |
So the three asset SIB has VTI, VEU and BND. The four asset SIB adds emerging markets. The five asset SIB adds Real Estate. The six asset SIB adds commodities.
Over the next set of articles, we are going to examine the differences between the portfolios and why the additional asset class makes a contribution to increasing return potential and lowering risk.
The three asset portfolio is really old school. The world comprises the US and the rest. US equities are enough of a microcosm that I can find enough diversification to give me protection against certain segments of the markets declining. Even if that does happen, I have fixed income and international equities to bail me out. We know that this is no longer the case. We can see on our browsers how the DOW, FTSE and NIKKEI act as if they are the same index, just on a different timezone. With a three asset portfolio, you really have very limited diversification.
Adding emerging markets does give you a completely different asset
Performance chart (as of Mar 1, 2011)
Performance table (as of Mar 1, 2011)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Three Core Asset ETF Benchmark Tactical Asset Allocation Moderate | 1% | 30% | 2% | 31% | 4% | 35% |
| Three Core Asset ETF Benchmark Strategic Asset Allocation Moderate | 15% | 129% | 3% | 15% | 4% | 18% |
| Four Core Asset ETF (EM) Benchmark Tactical Asset Allocation Moderate | 3% | 47% | 5% | 53% | 9% | 53% |
| Four Core Asset ETF (EM) Benchmark Strategic Asset Allocation Moderate | 14% | 120% | 3% | 10% | 5% | 20% |
We note from this that applying a tactical asset allocation strategy with three asset classes and funds is of limited value. Tactical asset allocation relies on having other asset classes that are not correlated so that when one asset class is under performing, another one becomes a hedge and rises to compensate. However, with an additional asset class, you are able to more than double returns over the longer time horizon. This is a significant jump and over a decade this puts 60% more money in your pocket.
Emerging markets are going to play a larger and larger part in our lives as countries such as China and India are increasingly powerful. We have already seen how these nations have sprung back from the great recession and are leading the recovery. This is an important part of any portfolio and if you want to know how to better your chances of a better retirement, now you know.
How can you do this if your plan only supports three asset classes? If you have an IRA, overweight the missing asset class (or two) in the IRA to compensate and create a more balanced portfolio that can deliver higher returns and lower risk.
Disclosure:
MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.
Or Start FREE 30-day trial now >>
