After watching a David Swensen lecture online some time ago courtesy of blogger Dividend Monk, I got thinking about my own asset allocation in more detail.
Some experienced investors might already know that David Swensen is the Chief Investment Officer of the Yale Endowment Fund, one of the most successful institutionally managed portfolios in modern financial history. Swensen started his job at Yale over 25 years ago and hasn’t looked back since.
As I learn more about investing and seek out successful role models for it, I gravitate to folks like Swensen because, well, you’re learning from the best. A big part of Swensen’s outstanding portfolio success over the decades can be attributed to his diligent attention to asset allocation for the Yale Fund. Swensen believes (and demonstrates through the fund’s success) that asset allocation is an essential part of the wealth generation formula.
Swensen’s book entitled Unconventional Success mentioned that investors should contruct a portfolio with monies allocated to the core asset classes below, keeping a bias towards equities. He suggests the following from his Unconventional Success book. I’ve added some well-known U.S. ETFs to be used as examples, since his book focused on U.S. investments:
- 30% Domestic Equity (VTI)
- 15% Foreign Developed Equity (VEA)
- 5% Emerging Markets (VWO)
- 20% REITs (Real Estate Investment Trusts) (VNQ)
- 15% U.S. Treasury Bonds (SHY)
- 15% TIPS (Treasury Inflation Protection Securities)
Dare I say this to such an esteemed expert with his track record, but I think Swensen’s recommendations are a little off.
For one, 20% REITs seems a big high. I prefer to go with something like 10% REITs. Besides, if you own your home or have a rental property, that’s too much equity in real estate. You need diversification away from it.
Secondly, for any retirement plan I think you want to have more equities. While I use my pension at work for my fixed income allocation I not want close to 30% in bonds and/or TIPs myself. That seems far too high anyhow since I think investors should learn to live with stocks more.
This is my desired overall asset allocation for any potential retirement:
- 60%-70% equity (a blend of individual stocks and low-cost ETFs).
- Max 10% REITs.
- Max 20-30% bonds*.
*The bond allocation will come from our workplace pensions.
Essentially, I hope to be around 100% equities outside our pensions and a modest cash wedge for semi-retirement.
Asset location summary
I don’t think there is a one-size fits all recipe for investors but overall Swensen’s recommendations definitely resonated with me albeit with a few adjustments to satisfy my personal goals for income and growth.
Footnote: Since this original post, on various websites, I’ve read that Swensen has altered his asset allocation in recent years, after Unconventional Success was published and largely due to the economic climate experienced through The Great Recession 2008-2009. Swensen now recommends investors have 15% of their assets in real estate investment trusts (REITs) and raise their investment in emerging-market stock funds to 10%.
What is your asset allocation?
Have you ever thought about it?
A couple of thoughts to share. Rick Ferri has a good analysis of REITs in his book All About Asset Allocation. Yes, they are a category of equities, and their long-term expected return should be the same as the broad stock market. But as a group they tend to move together, and they have low correlation with the broad market. By that definition, they are a discrete asset class, and therefore a good diversifier in a portfolio.
However, there is a practical problem with REITs: the sector is extremely small, especially in Canada. We’re talking less than 20 inestimable companies. So a 20% allocation makes no sense if you’re going to confine yourself to publicly traded Canadian REITs. You’d end up with a huge position in RioCan. 🙂
A pension or endowment fund might have 20% of its assets in real estate investments, but this will encompass much more than publicly traded REITs.
Thanks for the detailed comment Dan. I still need to read that Rick Ferri book, his latest one.
I definitely see the practical problem with REITs. I look at my own portfolio with RioCan, H&R REIT and think “that’s probably enough” since it’s almost 40% of the REIT market right there. Obviously that is not passing the diversification test very well. It would be like saying you owned Nortel over a decade ago and you had a good handle on Canadian equities. Bad, bad reasoning…
Your point about a pension fund having 20% of its assets in RE because it takes on more than publicly-traded assets is a good point, but still seems a tad high to me and further to that, the retail investor can’t complete with that. I guess that makes me confidence in the asset allocation I have chosen, less REITs, moderate foreign equity and a healthy dose of bonds.
So far, so good.
Asset allocation is personal, but no doubt like most things in life there are some best practices that should take strong consideration before deviating from them.
Susan Brunner is almost 100% Canadian dividend paying stocks. That blows the “best practice” out of the water yet it is working for her. She can’t argue with her resuults!
With the age-bond formula, I sometimes go back and forth on that one. Maybe 30% bonds is OK for me, for many years to come? I am lucky to have a DB pension, so that’s a very “big bond”, something I need to write about yet.
I must say, I like the monthly income/distributions rather in my RRSP with bond ETFs. A couple units are bought every month. It’s nice to see compounding working right in front of your eyes.
I appreciate your detailed comment!
MOA Great post! Asset allocation is such a personal choice isn’t it? A 100% dividend investor considers diversification among sectors as asset allocation, yet I consider that a 100% equity portfolio. Both Susan and Jon Evan bring up some good points don’t they?
I’ll agree with you on keeping REITs at 10% instead of 20%. I believe Swensen’s reasoning on REITs is based on REITs being uncorrelated with stocks, and bonds, and choosing the allocation for that reason (I may be mistaken).
I also agree with you on bonds at your age formula. It just makes good sense. The older you get the less time you have to recover from significant stock market declines and crashes. People also forget that bonds provide you with monthly income – regardless of interest rate environments 😉 I do believe that TIPS and Bonds are both lumped in the fixed income category, therefore 30% is reasonable, but low for me as well MOA.
Your asset allocation looks spot on to me, but I don’t think you need to go for 40% bonds until your in your 40’s (as old as me 🙂 you have the extra time to take advantage of the growth in equities – just saying 😉
The Dividend Ninja
Double or triple status, that’s good, right? 🙂 Have a good weekend 101!
@My Own Advisor
Actually, for me it is more like been there, done that and moved on.
I actually experimented in the past with foreign investments (via mutual funds), US investments, foreign stock sold on US market and bonds. For some of this, it was the problem I either lost money or did not make much. I still have a US currency account. The only thing left is Barclays Bank in this account.
I have also tried small caps, but they mostly died with 2000 bear market, recession. Now I am experimenting with dividend paying small caps.
US Stocks: They really seemed to get hammered more than my Canadian stocks when the market went south. I think the main problem was the currency risk. I never made much money here and then it because real difficult when the Canadian currency started to rise against the US currency. However, I do still track some US stocks.
Bonds: I made lots of money here. However, I was investing in bonds when the interest rate was high (19%) and falling. How could you not make money in such a market? Currently I have no bonds. I found the bond market more volatile than the stock market. Volatility depends on interest rate changes and length of term of the bond.
The fact is that David Swensen has a lot more money to handle than I do. There is in fact a huge difference. I think that I have a lot more choices that he does. I do not see how he could manage the huge funds he does without Asset Allocations.
As an investor, I think you have to find what works for you and do that.
So you’ve really learned from experience then, which is in my opinion, one of the best teachers you can have in life.
Dividend-paying small caps make sense, but I don’t have many because I want my portfolio to be more stable, with larger, more established companies.
US Stocks: I like the multinationals but few others.
No doubt you made a killing when rates were 19%. Will they go that high again? Who knows. I hope not. If bond yields get that high, we’re in big trouble with our current mortgage. In another 5 years, we’ll be fine.
Thanks for replying and breaking down your experience for us Susan; always appreciate reading and learning from folks who have “been there, done that” 🙂
Enjoy your weekend and chat more next week.
I like your asset allocation percentages 🙂 They seem very reasonable.
I myself must admit that I’ve been terrible with my asset allocation. That’s one of my goals to work on this year- to work on that!
I think they make sense, for me. I don’t think a perfect allocation exists, but there are certainly some best practices to leverage for your own portfolio. Just trying to read, observe and absorb. Cheers!
I must admit that I have read a lot of stuff on market allocations over the years, but I haven’t followed any of it. I am practically 100% in Canadian Stocks. (I have around 5% in cash as I am living off my portfolio.)
50% of my portfolio is in Finance and Utilities. (I might have been quite hammer with this if I was an American investing in US banks- but if I was an American, I might have a very different view point on investing.)
I have a minimal amount in resources (although Canada is a resource based country).
I have just over 6% in real estate.
Of course, I haven’t followed a lot of advice I have read on investing. So far what I have done seems to be working for me.
Thanks for your comment.
I think you’re proof that asset allocation, while important is not the be-all, end-all. I would think the majority of investors however, need good asset allocation but if you’ve been fortunate to accumulate as many dividend-paying stocks as you have, even with the Canadian bias, you probably have very little to worry about.
I like the allocation because, it gives me access to the world. Will those worldly markets return more than Canadian stocks will? Will it trail Canadian stocks? I will never know. I know I will not have to worry about the answer to that question.
In closing, I don’t think you fall into “the majority of investors” I eluded to above. I don’t know many people who live off their dividend income. It remains impressive to me and something to strive for.
Are you not worried about lacking some foreign exposure? I mean with 20% for US and international with half (or more) allocated to emerging markets makes it seem like you are missing out on a lot of strong international companies. Also, when Swensen speaks of domestic equities, he is talking about a market that is far bigger than Canada and one that is full of multinationals. It would be interesting to see what his breakdown for Canadians would be.
I personally have (all index funds)
10% Emerging Markets
Now it might seem like I am low on bonds but I am only 28 and have a pension plan through work so my investments are for future purchases and supplementing my retirement income.
Thanks for your comment. I hope you are enjoying the blog.
Worried about lacking some foreign exposure? Good question, but not really, because how I invest. I use VWO that captures a big part of emerging, emerged as I call them, markets and a few U.S. dividend-paying stocks. I would like to own VEA when the price is right, and then, a few more U.S. stocks. I feel I don’t need much else.
The reality is, most big blue-chips I invest in, U.S. stocks I mean, make almost if not more profits internationally than they do domestically. Take KO:US for example.
I think your allocation is pretty strong, and bullish outside Canada. Absolutely nothing wrong with that. Great stuff on the index funds as well. Smart stuff.
I don’t think you’re too low on bonds, you’re 10 years younger than I am and I had no bonds at 28 🙂
Asset allocation is a sloppy science. Some in their 60s need no equity allocation others need one that matches their age. While bond funds have had a spectacular rally that will end soon especially for short-medium bond funds as their inventory coupon yields begin to match current interest rates! Historically equities have always outperformed bonds. If one is in their 60s and working there is no reason to follow the ‘age in bonds’ adage. Remember that 60 is now the new 50 and for you Mark 40 is the new 30!
Thanks for the comment and stopping by. Where have you been?
Historically equities have always outperformed bonds, you’re right, which is why when I get to about 50, that’s where the ‘age in bonds’ adage might fall apart for me. 50% bonds, mostly in bond ETFs, will be my maximum. I can’t see much reason to go more than that, if that.
Agreed, if one is in their 60s and working there is no reason to follow the ‘age in bonds’ adage. Heck, if I get many more dividend-paying stocks in my portfolio like Susan Brunner a) I won’t be working at 60 and b) I won’t need any more bonds.
I wish sometimes, the new 40 would really be 30 but what can you do eh? Live, laugh and love I guess.
I like the increased exposure to emerging markets going forward. This has got to be one of the safest long-term plays going forward right? I mean, some transfer is wealth is inevitable at this point I think. I agree that the REIT percentage is a little high. I’m a fan of REITs, but that’s a little intense.
Thanks! I guess great minds think alike 🙂
I think some transfer of wealth is absolutely inevitable: I mean, it’s happening right now.
The U.S. and Canada to some degree will still be powerful economies, but the superpower(s) of tomorrow will not be the U.S., those other countries just getting their engines running.
I was about to say these allocations change, but I see you are aware of it. I respect Swensen and I have great respect for Buffett, but I don’t take their advice at face value. I tweak it to align with my temperament.
I think it is good to question facts and figures even if they are from the best.
Thanks for the comment!
I have huge respect for Swensen. I need to read more about him and the Yale Fund. That said, Swensen is dealing with billions of dollars, I’m dealing with, well, not billions of dollars…
So, I need to learn what I can and tweak it to align with my goals, my comfort zone and circle of competence.
With my investing, I don’t want to follow somebody else’s recipe. Doing it myself is the best teacher.
No such thing as a perfect asset allocation but your allocation suggestions sound pretty reasonable. I might have suggested a little less Canadian and a bit more foreign to get away from the “home-town bias” so many of us suffer from, but that might just be quibbling.
I just had a rather online blog spirited discussion with Mike at “Oblivious Investor” (an American blog I think) who believes very strongly that REITS are Equities and NOT an asset class in their own right. I disagreed as would many financial advisers in Canada and elsewhere (including notably Australia where I used to live) who very definitely see REITS as special. I’m very pleased to see you itemize it separately in your discussion.
Also pleased to see Yale splits it out separately and like you I agree that 20% seems a bit high. I have 15% in REITs and some of that in a US REIT ETF so as not to be too heavily weight to Canada.
Thanks for your detailed comment!
Yeah, probably a bit too much Canadian content for me, but I’ll work on bringing that down over time with some U.S. dividend-paying stocks, some more VWO and probably some new VEA, which will be new to my portfolio.
I don’t see REITs as the same as equities, they are a special breed of. Almost in the way Emerging Markets are Foreign Equity. A sub-set if you will but even then, that comparison is not fair. REITs don’t always behave like Canadian stocks. This is why I don’t think you can lump them together and all the more reason to own a few in your portfolio.
That’s just me. No expert, just reporting what I observe in my own portfolio 🙂
Glad you checked in Mark.
(From this Mark)