24 – Cultivate Through Asset Allocation


Episode Overview:

Continuing down the roadmap, Ken further discusses cultivating assets. There are different kinds of asset classes that you can look to invest in: Cash (or Cash Equivalent), Bonds, and Stocks (Equity). Exploring these different fields require an understanding of risk and what is called a “glide path.” Understanding your target date for retirement as well as your age factors into this glide path model, which outlines the amount of investment risk you take over the course of your life. Younger investors typically take on more risk, while those nearing retirement typically take minimal risk. Take a listen to this episode to understand where you should consider allocating your assets.

Transcriptions are auto-generated, please excuse grammar/spelling!

Happy day to you. This is Ken Kaufman CFO and I am thrilled you’re here for Episode Number 24, “Cultivate Through Asset Allocation.” Now, this is all part of a series of podcast episodes. Several that I’ve already done and several that are planned in the future where we’re focusing on this word “cultivate” and specifically, cultivating our assets. And as you recall, this is part of the overall IMPACT Your Net Worth model, IMPACT being the acronym and the “C” in impact standing for “Cultivate your Assets.” Today, as we talk about asset allocation, any time you’re going to save money, you have three main asset classes that you can use in order to safeguard or invest or set aside this money for whatever purpose you’re setting it aside for.

So, the first one is referred to as cash and cash equivalents. These would be bank accounts, checking accounts, savings accounts, high-yield savings accounts, CDs at the bank, places where, as we learned about in the last episode, your goal is primarily preservation of capital. The second is bonds. These are income-producing assets. A bond is merely an agreement between one party to another party that says, “I will loan you this money. And in doing so, I expect interest to be paid and then at some point down the road, I want my principal to be repaid as well.” And bonds range in types from very, very safe short-term Treasury bills that are just 30 days or 60 or 90 days, all the way to 30-year bonds in what’s called a high yield type of a bond. That’s the nice name that Wall Street put on what used to be called or referred to as junk bonds.

These are corporations or institutions that borrow money that have very low or poor credit ratings. And so they tend to pay higher yields because if you’re gonna be taking more risk that the payer may not pay you down the road, you’re gonna expect a higher rate of return. And so they range all the way from these junk bonds that are long-term where you’re gonna expect the highest return, but there is risk there, all the way down to what you call relatively safe Treasury bills and Treasury bonds. And then the third is stocks or equities. And these range in risk as well from those that you’re gonna expect a ton of volatility out of to those that are much more stable and pay stable and steady dividends.

When you are deciding to invest, how you allocate your money between these three asset classes is gonna tell a lot about the type of risk you’re exposing yourself to and the type of return you’re going to get. And I’m gonna talk about this just on a very high level. And, again, remember there’s no investment advice being given. I don’t know anything about each of your individual situations. This is merely for education about how this works. You have cash or savings, cash and cash equivalents. You have bonds. And then you have stocks. Now, I wanna teach you about a concept really quickly called the “glide path.”

If I am 20 years old and I wanna start saving for retirement today and I have this goal of retiring when, let’s use 65. I realize lots people have different ideas. “I wanna retire early,” or “I wanna work until the day I die,” or somewhere in between. We’re just gonna go with, “Age 65 is when I’m going to retire.” That means I’ve got 45 years. The amount of risk that I’m probably willing to take today should be higher than when I’m getting to five years away from retiring and needing to start using that nest egg that I’ve been saving and invest in building up. I’m getting much, much more conservative the closer I’m getting to the time that I retire. And there are models out there all over on the internet. I mentioned Paul Merriman. He even has a version of this. They’re called “Glide Paths.” A glide path is, if I’ve got my retirement date down the road, I’m going to invest it and my asset allocation is gonna be heavily weighted toward more risk, so more stocks and less bonds and cash. And, as I get closer to the target date, this fund will automatically start to go more conservative with less of a percentage of stocks and more bonds and more cash.

So, I wanna take you through. I did a quick analysis of Vanguard Investments’ what are called Target Retirement Date Funds. And they have created them in five-year intervals. Starting with the most recent is what’s called the “2065 Target Retirement Fund.” And this means that you are close to retiring at somewhere around 2065. So, right now today a 19, 20-year old, they’re gonna be 65 years old in 2065. That means they were born probably right around the year 2000. In their Target Date Retirement Fund, there’s 90% in stocks, 10% in bonds, and 0% in cash. And what’s interesting then, because Vanguard has created one of these funds in five-year intervals and those who choose to use these funds to invest in, they are coming with this glide path concept that over time, the asset allocation will change based on their nearing retirement. So, people will pick the fund date that’s closest to when they anticipate that they’ll retire.

And so, when I jump from the 2065 fund down to the 2060 fund, this is somebody who right now is maybe 24 or 25 that’s gonna retire at age 65. It’s still a 90/10 split. I’m by the way rounding a little bit just to make this simple and easy. Even when I jump to the 2055 fund, those that would retire at that date, it’s still a 90/10 split. I’m gonna keep going. The 2050 fund, even the 2040 fund. So, that’s all the way to somebody who’s almost 40 years old. They will call 40 years old. They stay in this 90% stock, 10% bond, 0% cash scenario. Now, I will tell you this. There are some who say when you’re 19, 20 years old, 25 years old, even all the way up to 35 years old, you should have no bonds. Vanguard has decided in their Retirement Target Date Funds that they are gonna have 10% of bonds and 90% stocks. And there are some academic studies that show that you can generate the same return with less risk or less risk exposure. But again, there’s different philosophies around that. I ‘m not gonna get into it. Just wanna get you understanding this concept of a glide path.

When an individual then is 45, they’d be in this 2040 fund. Now, we have the entrance of more bonds and fewer stocks. Instead of a 90/10 split, you’re down to about an 83% stock, 17% bond split. And then as we’re getting closer to retirement, the 2030 fund or somebody who’s about 50 or, I’m sorry. Somebody who’s about 50 that’s the 2035 fund, they are at about… It’s pretty close. It’s about a 75% stock, 25% bond asset allocation. Then, somebody who’s 55 roughly, the 2030 fund, this is about 69% stock and about 31% bond. Now, somebody who’s 60, so, we’re getting really close to that retirement date. Somebody who’s 60, it’s now ratcheted down to where there’s roughly 60% stock and 40 % bond. And then when I get to age 64, this is now at 50… I’m gonna just round this off here. It’s basically about 51% stock, 41% bond, and the rest, which that would be 8%. The rest is in cash. This is basically right when you’re retiring at 65 or somewhere beyond. It’s called the “2020 Target Retirement Fund.” So, it would be next year.

And then there’s also…they have a 2015 retirement fund that was created, obviously back a while ago and now those who invested in it and they stay invested in it, it has now gotten to a point where it’s 38% stock, 49% bond. And then I think that makes 13% or 12% left that’s in cash. So, this is an interesting concept and I think it really helps teach what asset allocation is. It says that “The more risk that I’m willing to take, and as we learned in the last episode, that means we should also, for each unit of risk we’re willing to take, we should be expecting and building a portfolio that allows us to see a higher return. The further away I have, the more time I have to deal with the risk and the volatility and all the ups and downs of the market. I can wait that out and ultimately, achieve a better outcome.” Again, this is from all the academic studies.

There is a power in this glide path concept. And we learn a lot about asset allocation that the higher return you want and the more risk you’re willing to take, you allocate your assets more toward stock and the closer you’d be towards, in this case, retirement or to when you need your money, the less risk you would likely be willing to take. Now, if you have an income source that’s gonna pay for your retirement and give you plenty to live on, you may decide this investment. You wanna continue to be aggressive, you want to have it go to your children and grandchildren, and you have an estate plan around all of those sorts of things, obviously, the objectives can change and you can stay more aggressive. In fact, I read a story in an article. I wish I could remember where I saw this, but it was about a couple who well into their retirement years, they stayed in aggressive growth stocks, no fixed income or bonds whatsoever even until the husband died. And I wanna say that the wife was 85 or 90 years old and was still in all aggressive stocks. Her kids and grandkids were all telling her, “You need to be more conservative and preserve your capital.” And she just refused to do it. Interesting story.

Asset allocation is the name of the game. You have to understand when you are going to save. Again, at the very far end, cash, bank accounts, and high-yield savings accounts, that’s the place you go when you want to expose yourself to less risk and you might not even keep up with inflation. That’s a legitimate risk. And then you swing more towards bonds and then towards stocks as you want to go up the risk scale as well as the potential return scale. So, this is the concept of asset allocation. The one last thing that I wanna just touch on is the concept of rebalancing. So, when you say to yourself, let’s say that I want a portfolio of 80% stock and 20% bond and no cash. And after a year, let’s say stocks do really well and bonds don’t do well.

Well, the portfolio naturally starts to get out of balance and the stock portion might become 81% or 82% and bonds drop to 19% or 18%, or it could be vice versa depending on what’s going on in the market. Or maybe both go down but they stay at 80 and 20 or they both go up and it still stays at 80 and 20. Whatever the scenario is, you should rebalance on a regular basis to make sure that you maintain whatever your asset allocation strategy is. Studies and research have been done on this, that those who allocate too frequently actually can hurt returns. And so the general rule of thumb, and there are studies around this, is you should be allocating probably annually. You might be able to make a justification for quarterly, but annually makes sense. Even if it was every two years, at the end of the day, what’s more important to what your return is going to be is about buying and holding and sticking with whatever your strategy is. Even if it takes you an extra few months or an extra year to get around to rebalancing, what’s more critical is that you have your plan and you’re not changing your plans, selling out when the market goes down or any of those sorts of things.

And it’s a very simple process to rebalance. I rebalance annually. I set the date on my wife’s birthday. And every time she has a birthday, I know that’s the day that it’s time to do a rebalance. And it’s very simple. You just sell whatever is over its allocation percentage and you put that into whatever is under its allocation percentage. And if you have multiple holdings between the U.S. and International, and large and small, and value and growth, then it’s a little bit more complicated, but nothing a spreadsheet can’t solve and a little bit of math to really get you back into your full allocation. And what’s the logic for that? Well, if an asset class here, if your stocks are doing well, let those go ahead and run up for a while or bonds are doing well, let them run up for a while before you sell and go put them in what’s performing at a lower amount. That’s why daily or weekly or monthly they found that that can actually hurt the overall performance of a portfolio. But quarterly, annually, right in that range seems to be about the right place. Annually works great for me.

If you have assets that you’re not contributing to anymore, it’s more critical if you’re contributing to the assets. Then if there’s any way that what you’re putting in could go to just on a consistent basis, put it in what’s underweighted to build up your asset allocation back to the right percentage. That’s also a great strategy. But again, that only works if it’s something that you’re currently contributing to. So, there it is, cultivating your assets through asset allocation. This is a critical element of understanding how you’re saving, what decisions you’re making, and what potential returns you could potentially see. So, I wanna just encourage you to subscribe to the podcast. We have several more episodes including we’ll jump into diversification, we’re gonna get into expenses and a lot more around saving and understanding what the true cost of saving and investing is and how to make sure you’re setting yourself up to be at least as successful as you possibly can, based on your investment objective and your overall strategy. Many, many thanks to you for joining today. This is a wrap for Episode 24. Happy day.

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Join Chief Financial Officer Ken Kaufman as he helps you track and hack your net worth. For those seeking financial independence, your net worth is one of the most significant measurements of success. Using his two decades of financial experience, Ken Kaufman helps you overcome your financial obstacles and look onward towards a better, brighter financial future.


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