Asset Allocation 2.0

Please note the publish date of this blog. Financial information, market conditions, and other data mentioned in this post may no longer be accurate or relevant.

What if everything we’ve been taught about asset allocation is all wrong? No more questions about how much risk you can tolerate, how you coped in 2008, or putting more and more of your portfolio into bonds as your age. What if instead, you divvied up your assets based solely on the goals you want to achieve, and the time you have to achieve them? Let’s look at an example.

Matching Goals to Assets

1.5 Million Net Worth
$1.5 Million Net Worth

Consider a client, age 65, with $1 million to invest. The client owns her home, which is worth $500,000. Here is a chart of her total net worth.

Every year, the client withdraws $50,000 from her investments to sustain her lifestyle. To be safe, we assume that she will need this money for 35 years, until age 100. We separate this period into the first 10 years and then the following 25 years, primarily because if there’s a market drop in the first few years, it’s harder for her portfolio to recover in time to fund those first 10 years of withdrawals.

For the first 10 years we estimate that $500,000 of bonds will best cover her withdrawal needs. The money she will need in years 11 through 35 is best matched today with $500,000 in the ownership of companies and real estate (collectively, “equities”). You might wonder how she’s going to fund 25 years of spending with the same amount ($500,000) that she’s using to fund the initial 10 years. The answer is that for the longer and later period, the equities will have 10 years to grow before she starts withdrawing from them, and over full market cycles, equities earn roughly twice the annualized return of bonds. The client would also like to leave $500,000 to her son as an inheritance, for which we could earmark the equity in her home.

Matching Each Goal with Assets
Matching Each Goal with Assets:
50% Equities/50% Bonds

In this diagram, we show what matching of her assets to her goals looks like. As you can see, this approach tells us that the mix of equities versus bonds for this client should be split 50/50.

Just the Right Amount of Risk

This approach is in stark contrast to a popular school of thought that says the bond allocation percentage should be equal to one’s age (so for this client, 65%), since that allocation would fall short in providing the growth required for the client’s spending needs in her later years. Our approach also differs from the tendency to go with the popular 60/40 balanced portfolio for almost all investors (60% equities, 40% bonds), which would unnecessarily increase the client’s risk. When we start with the client’s goals, we can ensure that the amount of risk the client takes meets the “Goldilocks and the Three Bears” test: not so aggressive that we’ll have sleepless nights and not so conservative that we’ll run out of money. Instead, the amount of risk for each client is “just right.”

Disclosure

Abacus Wealth Partners, LLC is an SEC registered investment adviser. SEC registration does not constitute an endorsement of Abacus Wealth Partners, LLC by the SEC nor does it indicate that Abacus Wealth Partners, LLC has attained a particular level of skill or ability. This material prepared by Abacus Wealth Partners, LLC is for informational purposes only and is accurate as of the date it was prepared. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Advisory services are only offered to clients or prospective clients where Abacus Wealth Partners, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Abacus Wealth Partners, LLC unless a client service agreement is in place. This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Abacus Wealth Partners, LLC is not an accounting or legal firm. Please consult with your tax and/or legal professional regarding your specific tax and/or legal situation when determining if any of the mentioned strategies are right for you.

Please Note: Abacus does not make any representations or warranties as to the accuracy, timeliness, suitability, and completeness, or relevance of any information prepared by an unaffiliated third party, whether linked to Abacus’ website or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

For more information about Abacus and this article, please read these important disclosures

Share:

What’s your financial archetype?

Simplify your life with a plan

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut elit tellus, luctus nec ullamcorper mattis, pulvinar dapibus leo.