The Only Asset Allocation Guide You’ll Ever Need

0:00So forget obsessing over whether your stock fund should be Vanguard or Fidelity, or whether your bond fund should be intermediate or long-term. those choices, dare I say, don't actually matter. It's the allocation percentages that drive your returns, your risk, and your ability to stay the course when things get ugly. Hello friends, this is Tyler Gardner welcoming you to another episode of your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing. So let's get started and get you one step closer to where you need to be.

0:46I want to start this week's episode with a quick thought experiment. Imagine two investors. Investor A has a portfolio that jumps 20 % one year, then 0 % the next. Investor B has a portfolio that climbs a steady 10 % each year. On paper, both average the same return, 10%. But after two years, investor A has$120. Investor B has$121. Some of you may have seen this example before, and for others it might be new. Regardless, it's crucial we start this week's episode here. because in this particular example, after one year, that$1 difference doesn't sound like much, but let's think long term. Over decades, it compounds into thousands, even millions of dollars.

1:45And the point is this, the average return you get is not the same as the return you actually get. The even more pressing point is this. Just because you crushed the stock market this year doesn't mean you're going to crush it long term, nor does it mean that your allocation strategy is sound or genius. Because volatility drags you down. And the number one enemy of long-term wealth, especially in retirement, isn't missing the big winner. It's suffering the big loss. Remember, if you lose 50 % in one year, you don't need a 50 % gain the next year to break even. You need 100%. Let that sit with you for a moment as I take a sip of my new favorite Jamaican coffee from the Woodstock Farmer's Market, cleverly called Jamaican Me Crazy.

2:49No, they're not sponsoring me, but it is dang good coffee. They're very clever over there, and they have exceptional cookies too. This example, not the cookies, is why asset allocation matters. We're not looking for the asset class with the flashiest year. The hot stock, the crypto moonshot, or whatever Uncle Bob is raving about at Thanksgiving. What we're really after is a mix of assets that don't all win or lose at the same time. The jargony academic terminology we need to know here is called non or negative correlation. I've talked about this before. It just means that if one asset class responds to macro or micro trends by going down, hopefully we have invested in another asset class that responds to those same trends by going up.

3:45We need to focus our attention on gathering pieces in our portfolio that offset each other so the portfolio as a whole compounds steadily even when individual pieces wobble. And the data backs this up. A classic study by Brinson, Hood, and B. Bauer found that more than 90 % of portfolio returns come not from stock picking or market timing, but from asset allocation itself. And not just asset allocation throughout your life, but the initial asset allocation that you choose. Meaning, if you spend one hour doing this well, in all seriousness, that hour will and can define 90 % of your ultimate returns in life, regardless of what happens in the world.

4:38In other words, your long-term results are driven far more by how you divide the pie than by which toppings you constantly obsess over. Again, there's a reason that in any Wall Street movie ever, the top brokers are always mentoring the new person by telling them that stock picking is a fool's errand. I will extend that to picking one thing inside an asset class is almost irrelevant versus how you divide the entire pie across asset classes. That's what matters most. And here's why we're talking about this now. In the listener survey, I sent out and a massive thank you to all who filled it out.

5:22By the way, I got about a thousand responses and you all are amazing for offering what this show can do better and what you want to see. And the link is still live in the show notes. If you didn't get a chance to fill it out. I asked you all what you wanted to hear most about, and asset allocation was absolutely consistently one of the top things you wanted covered, which makes sense. It's the unglamorous but essential backbone of investing. So I'm proud of all of you for whatever that's worth for wanting to hear more about this relatively dry topic. And I'm happy to cover asset allocation and in typical fashion, because it's a dry topic, we're going to try our best to have some fun with it.

6:05Because if you ever take life too seriously, you're missing out. Start here. Asset allocation isn't a horse race. It's more like a Thanksgiving dinner. Aunt Karen swears mashed potatoes beat stuffing. Uncle Bob won't shut up about cranberry sauce. And cousin Chris will only eat the dark meat and you've placed him last in line to get food because he's been known to take it all and leave none for the rest of you. But the truth is that people love Thanksgiving dinner because you have options and you get to mix and match and it works as a plate. Hence why so many sandwich shops have created the gobbler or whatever they want to call it these days.

6:47And quick sacrilegious side note, am I the only one that doesn't like any food that's served at a traditional Thanksgiving? I continue to be blown away that we're still pretending that any of that food is good. If I just lost you, I'll do my best to get you back with what follows. If you prefer another image other than Thanksgiving to understand asset allocation, think of Noah's Ark. You don't load up on giraffes just because they look cool and have long tongues that can eat the food out of your car. You bring two of everything. That way, when you one day find dry land again, you're not the one explaining extinction to the grandkids.

7:27Enough of my rambling. Here's the roadmap for today's episode. First, we're going to take a tour of all the major asset classes, warts and all. Second, we're going to walk through three practical allocation strategies that you could actually follow depending on your tolerance for risk. And third, we're going to bust one of the biggest myths in retirement investing, the conventional glide path of shoveling your money more and more heavily into bonds as you age. Honestly, I think that's 100 % backwards. And come on, y 'all knew I was going to say that. And as always, a quick favor before we jump in.

8:08If you've been enjoying the show, leaving a review on Apple Podcasts really helps more people find it. And it helps me know what's connecting with you. I read every one, and I appreciate all the support you've shown for the show and how I can continue to make it better for you. All right, let's open the gates and take a stroll through the zoo of asset classes. Everyone behave. Each asset class has its quirks. Some are majestic, some are smelly, and some will absolutely bite you if you're not careful. Starting with number one, stocks, or the star quarterback that we all know and sometimes love.

8:50Everyone loves it when they're winning. Stocks are the charismatic, occasionally cocky quarterback of your portfolio. They've historically delivered the highest long-term returns, about 7 % annually post-inflation in the U.S. market over the past century. But they also throw spectacular interceptions at the worst times. See the dot-com bust, the great financial crisis, and yes, March 2020, when the S &P fell 34 % in 33 days. The key with this asset class, stocks will build your wealth, but they'll also test your stomach lining. And that's why for textbook asset allocation, we tend not to put them on the field alone.

9:38If you want to dig deeper here, check out Burton Malkiel's A Random Walk Down Wall Street or John Jack Bogle's The Little Book of Common Sense Investing. Both argue that stocks work best when you buy broadly, cheaply, and for the long haul, aka what I've been preaching for years, and yes, I got it from the best. Number two, bonds, the responsible accountant. Bonds are like that accountant friend who insists on splitting the dinner bill down to the penny. They're relatively stable, predictable, occasionally boring. Historically, long-term U.S. treasuries return around 5 % a year. That's nominal.

10:20But that average hides the fact that bonds can and do get hammered by inflation. Think of the 1970s. Or rising interest rates. Hello 2022. I hit on this back in episode 7, title, Should I Invest in Bonds? And if you want a deeper dive into my thoughts on bonds and investing in bonds, check out episode 7, titled, Should I Invest in Bonds? So, why do people bother with bonds? Because bonds are not in your portfolio to beat stocks. I need to repeat that because it is the biggest myth conception that I hear daily from many of you. Bonds are not in your portfolio to beat stocks. They're there to soften the blow when stocks fall.

11:11See our initial example where we started the show of 10 % 10 % returns versus 20 % 0%. In 2008, for instance, the S &P lost 37%. Long-term treasuries were up around 25%. That's not glamour, that's insurance. And that's the heart of asset allocation. We never know for sure what's going to zig while something else zags. So we hold both stocks and bonds in a textbook simple allocation, even if it's just a tiny sliver of bonds. For me, I just use short-term money markets to fill that gap in my own investing. Together, stocks and bonds keep your arc afloat. And for bond geeks or aspiring Nick Caraways who are listening, Larry Swidrow's The Only Guide to a Winning Bond Strategy You'll Ever Need is a surprisingly approachable primer for you.

12:11Asset class number 3. Real estate, or the needy roommate slash tenant. Real estate can look so solid. The house you can touch, the rental income you can collect. It's often pitched, mainly on social media, as the inflation hedge of choice. And yes, it can be. But depending on how you choose to invest in it, it can also be highly illiquid, meaning can't convert to cash for a fair price as soon as you might like, maintenance heavy, and prone to dramatic market cycles. Remember 2008? Or watching the big short with a stiff drink. For everyday investors, REITs, real estate investment trusts, offer exposure without the midnight calls about a leaking roof.

13:02You don't need to become an expert in multifamily housing units to access this asset class. And historically, US REITs have returned around 8 % nominally speaking annually, but with stock-like volatility. They tend to do better when interest rates are lower because more people are apt to access cheap capital to build, to rent, to lease, etc. And if you want more about real estate, William Porvu's The Real Estate Game gives a thoughtful look into how professionals view property beyond location, location, location. Asset class number four, alternatives. The crazy cousin. Private equity, hedge funds, commodities, timberland.

13:51The exotic cousins of investing, if you will. They promise exclusivity and non-correlation. Translation, when stocks and bonds both struggle. Alternatives might behave differently, and sometimes they do. In 2022, for example, when stocks and bonds both fell dramatically at the same time, alternative funds did help balance many portfolios. But beware, the fees to access this class often make your eyes water and access is limited and potentially illiquid as well. For everyday investors, commodity ETFs or a dabble in gold are the more practical routes. Historically, commodities shine in inflationary bursts, but they also can deliver decades of disappointment when other components and asset classes are doing well.

14:46For me, I'd invest no more than 5 % of my investable assets in alternatives and only for these super rare moments when both stocks and bonds are sliding. For a thoughtful critique of alts, you could check out David Swenson's pioneering portfolio management because he helped Yale build one of the most successful endowments with heavy use of alternatives, though most of us won't get Yale-level deals. Asset class number five, and yes, I'm distinguishing this slightly from alternatives because it does deserve an asset class of its own at this point in time, crypto. The wild child who is going through a goth phase and nobody really knows how it's going to turn out.

15:30Unless you're that child who swears it's not a phase and they're dressing in black for life. Crypto. Equal parts philosophy, speculation, and chaos. In the 2010s, it minted overnight millionaires. In the 2020s, it also minted spectacular bankruptcies. Bitcoin has returned more than 200 % annually in its first decade, but with occasional drawdowns of 80 % or more at times. Should you dabble at this point? Maybe. I'm not here to tell you what to do. But should you bet the farm? Okay, I am here to tell you what to do. Absolutely not. And too many people are currently choosing to bet the farm. This is the textbook case of people thinking that they should go all in who don't understand the long-term price of volatility.

16:26Crypto is like giving your portfolio a red bull and hoping it doesn't crash through the freaking coffee table. The key takeaway from all of this, every asset class has its pros and cons. The point is not to crown a winner. The point is to have a mix so that no single one, whether it's stocks or bonds or real estate or even your wild child crypto experiment, can tank your entire financial future. As the Brinson study and every market crash remind us, long-term wealth isn't built by betting on the star quarterback. It's built by making sure the accountant, the roommate, the crazy cousin, and yes, even the wild child all play their roles without sinking the arc.

17:15Now, let's look at a couple different ways to practically slice this pie. And to repeat for a third time, the only stat you need to take away from this episode is that 90 % or more of the variability in long-term returns comes from how you split this pie across asset classes, not the stock picking you do inside of them. You can agonize over Apple versus Microsoft all day long. It's fun to talk about. But if 90 % of your money is in stocks, your fate is tied to the stock market full stop. So let's look at three simple models you could actually follow. Think of these less as prescriptions and more as menus from which you can order, depending, of course, on how much risk and how much stomach lining you've got to spare.

18:11Number one, I'll call the cautious camper, aka I'd like to sleep at night, thank you very much. In this allocation strategy, you might consider 40 % in stocks, 50 % in bonds, 10 % in real estate and alternatives. Here are the pros of this type of allocation. Much lower volatility, volatility, relatively steady income, and far fewer nights staring at the ceiling wondering if you should have just raised goats in Vermont instead. This mix historically delivers around 4 % in real terms with shallower drawdowns than an all stock portfolio. Cons. Growth is going to be much slower. This is where I remind you all that you cannot compare this type of allocation to the returns of someone with 100 % stock allocation.

19:06That's not fair. This allocation strategy is not expected to beat the stock market. Additionally, inflation eats away more of this type of allocation over time because you're more heavily invested in bonds. You may not run out of money depending on your needs and starting principle, but you also may never get to splurge on that Italian espresso machine that costs more than your first car. Allocation number two, we'll call the balanced hiker, aka let's play it smart, but not necessarily boring. This could be 60 % stocks, 30 % bonds, 10 % real estate alternatives, and crypto. Pros. This is the classic moderate portfolio, close cousin of the legendary 60-40 portfolio that's been the bread and butter of pension funds for decades.

20:02Historically, this setup has returned about 6 % in real terms, annualized since 1926, with fewer gut punches than all equity. And for many of you, depending on starting principle, 6 % a year in a steady manner might be enough and might be fantastic. This allocation would provide you with enough growth to outpace inflation, and enough stability to stop you from panic selling when CNBC starts plastering red arrows on every chart. Cons, now we're increasing vulnerability to big downturns. You'll lose money in a bear market, just not as much. And yes, you'll second-guess yourself during bull runs when your mountain climber friends brag at cocktail parties.

20:50Which leads us to asset allocation number three, the mountain climber. aka I'll sleep when I'm dead. 90 % stocks, 5 % bonds, 5 % real estate, alts, crypto. Pros, maximum long-term growth potential because U.S. stocks alone have returned about 7 % a year over the past century in real terms. And history says the odds are in your favor if you can actually hang on. As I've noted before, Warren Buffett has prescribed that his entire net worth will be allocated at a 90-10 mix, 90 % to the S &P 500, 10 % to short-term treasuries for his own family. And note, that's what I do with my own portfolio for what it's worth.

21:40And you can check out my episode from two weeks ago to see exactly what I am currently invested in and why. The cons, this can be gut-wrenching volatility during the downtimes. Think Everest without oxygen, if you are a panic seller. And research shows that most of you are. And, by the way, remember that Dalbar studies estimate the average investor underperforms the market by 3-4 % annually because of bad timing. You're going to wreck the plan faster than you can say dot-com bubble. The point of these three allocations is not to find the winner. It's to match your portfolio's allocation to your own behavior.

22:25If you pick the mountain climber, but secretly have the risk tolerance of the camper, you're signing up for misery and probably terrible decisions at the worst possible time. So forget obsessing over whether your stock fund should be Vanguard or fidelity, or whether your bond fund should be intermediate or long term. Those choices, dare I say, don't actually matter. It's the allocation percentages that drive your returns, your risk, and your ability to stay the course when things get ugly. Now I want to provide a quick note on target date funds, where they fit into this, and what's called the reverse glide path.

23:08Target date funds are like the Costco rotisserie chicken of investing. Cheap, dependable, and designed to feed a crowd. You set your retirement year, buy one fund, and voila, it automatically shifts from mostly stocks as you're younger to mostly bonds as you get older. No annual rebalancing, no spreadsheets, no late night debates about small cap versus mid cap, Just chicken and rice, every meal, forever. And that's the catch. Most target date funds live inside 401ks and only play with two main ingredients, stocks and bonds, which is fine. But also, like being told every dinner will be chicken and rice.

23:56Nutritious? Sure. Exciting? Not so much. They do minimize hassle, but they also leave out some potentially useful side dishes like real estate, commodities, or other diversifiers that could help hedge inflation and reduce risk. Now, let's once again myth bust some conventional wisdom. The standard advice that many of you have heard, as you age, you should hold more bonds and fewer stocks. Why? Because supposedly grandma can't stomach volatility. Well, I've connected with many of you out there who consider yourself or are literally grandmothers. And guess what? Many of you can stomach volatility.

24:40So forget the myth and learn about who you are. This is where we enter the glide path. The glide path concept stated that your portfolio should slowly glide down into the sea of bonds, like a plane landing on a quiet runway in Nebraska. And as you get older and get closer to death, more bonds and more bonds and more bonds and more boring and more boring and more boring. But here's the problem with that. Research, you know, that thing that actually talks about facts, shows the biggest risk in retirement isn't volatility. It's what's called sequence of returns risk. Translation, if the market tanks in your first three to five years of retirement, that's your biggest danger, and it could permanently cripple your nest egg.

25:30So think of it like hitting a giant pothole in the first mile of a cross-country road trip. Your shocks are blown, and you've still got 2 ,000 miles left to go. That's why some researchers, like Wade Pfau, among others, have argued rightfully for what's called the reverse glide path. I love this model. Instead of slowly easing into bonds more and more forever, you start retirement with more bonds to cushion those early years, then gradually increase your stock allocations as you age. Counterintuitive to what you've heard? Absolutely. But it reduces the odds that a bear market in year one sends you from the golden years to the greeter at Walmart years.

26:19And now, later in retirement, when your spending may naturally taper anyway, you can let stocks carry more of the load. Because that's when growth really matters. Not to fund ski trips in your 60s, but to keep you solvent and independent in your 80s and 90s. And some quick key data points to back this up. I promise I won't make this too boring, but it's worth having the numbers. A Morningstar study showed that retirees who started with a bad sequence of returns, aka a crash early on, had up to 30 % less wealth at age 80 compared to those who hit good years early on, even with the same average return.

27:02Back to the initial example of this show. Second, Fow's research suggests a reverse glide path reduces this failure risk, aka running out of money, compared to the traditional glide path. So, in summary, target date funds aren't bad. They're just blunt and simple instruments. They'll get you down the mountain, but maybe not with all your gear intact. With a little nuance, thinking about sequence of returns, adding in diversifiers, maybe even flipping the glide path logic, you can build a portfolio that doesn't just land the plane, but keeps you flying comfortably for decades. So that's asset allocation.

27:43It's not the sexiest part of investing, but it is easily the most important. It's the difference between building a flashy one-hit wonder portfolio and building a system that actually gets you through decades of markets, bear attacks, recessions, and whatever else history decides to throw at us. Remember, you do not need the perfect mix. Perfect is the enemy of great. You need a mix that fits your goals, your temperament, and lets you actually live your life without staring at market tickers like their blood pressure readings. Pick your allocation, automate it, and get back to something more fulfilling, like cooking dinner, walking the dogs, or winning an argument about Thanksgiving side dishes.

28:33I hope that gives you something to think about for the week ahead. And as always, thank you for listening. Thanks for tuning in to your Money Guide on the Side. If you enjoyed today's episode, be sure to visit my website at tylergardner.com for even more helpful resources and insights. And if you're interested in receiving some quick and actionable guidance each week, don't forget to sign up for my weekly newsletter, where each Sunday I share three actionable financial ideas to help you take control of your money and investments. You can find the signup link on my website, tylergardner.com, or on any of my socials at Social Cap Official.

29:11Until next time, I'm Tyler Gardner, your money guide on the side, and I truly hope this episode got you one step closer to where you need to be.