William J. Bernstein, in his most recent book, “The Investor’s Manifesto” writes, “Before diving into the most important issue faced by any investor–the asset allocation decision–you will need to understand four things: save as much as you can, make sure you have enough liquid taxable assets for emergencies, diversify widely, and do so with passive or index funds.“
If you are not a saver, it is questionable how much useful information you will derive from ITA Wealth Management. Perhaps I can persuade or scare you into saving more than you ever thought possible. This blog is also about diversification and using index funds or index ETFs as the primary investment vehicles. My preference is to use index funds for smaller portfolios and ETFs for larger portfolios. If one can hold commissions to something below 50 basis points per transaction, then I favor ETFs. It is now possible, through TDAmeritrade, to populate a well-diversified portfolio with commission free ETFs. Drive costs lower as it works to the bottom line. And now to that most important investment decision — one of asset allocation.
The first decision, and the most important according to available research, is to determine the stock/bond ratio. Will it be a 50/50 or a 90/10 ratio? This decision is unique for each investor, and to help with this determination, once more I direct investors over to http://www.ifa.com for the Risk Capacity Survey. If you have not already done so, take this survey to see where you fit on the stock/bond continuum. The next asset allocation step is even more difficult as one now needs to decide what asset classes will make up the equity portion of the portfolio and what bonds to use for the bond portion. A lot of attention is given to these decisions here on the Platinum level of ITA Wealth Management. Once the different asset classes are identified, investors are ready for the last decision and that is — what percentage should be allocated to each asset class? For example, if 40% is allocated to bonds do you place all 40% in BND or is it better to divide bonds into several different bond ETFs such as TIP, HYG, TLT, JNK, PCY, BIV, and BND, or some other combination of different ETFs? This is were we rely on some correlation analysis, particularly when it comes to the different stock or equity asset classes.
More recently we have been using the Weighted Momentum Ranking Spreadsheet as a guide to ETF percentages.