Size Matters: Asset Allocation Edition

Size Matters. Particularly, the size of how many equities/bonds/cash/alternative investments/etc. you have in your portfolio matters.

If you read my last post, How To Become A Millionaire, you know exactly how much to save per month to get a million dollars. But in those cool charts, we assumed a 5% return. While this is very conservative by a lot of people who show those types of charts, you could still not reach that if you have the wrong asset allocation in your portfolio.

For the basis of my arguments in this article, let’s just assume you have two mutual funds in your portfolio. VSTAX (equities) and VBTLX (bonds).

If we look back on history, which I hate doing because the markets are unpredictable but it’s all we have to go on, for the past 15 years, the annualized return is 8.25% for VSTAX and is 4.41% for VBTLX. That might have been a run-on sentence. Not sure.

However, check this out. Say we have two portfolios: Portfolio A and Portfolio B. Portfolio A has a 90/10 allocation of stocks to bonds and Portfolio B has a 50/50 allocation of stock to bonds. This would create an annualized return of 7.87% and 6.33% return, respectively.

You would have an additional $20,000 if you invested in Portfolio A for 25 years instead of Portfolio B if you just initially put in $10,000. Check out my fancy chart:

Portfolio A Portfolio B
Initial Investment  $       10,000  $      10,000
25 years later  $       66,392  $      46,387


If you put in $500 into your account each month, you would have an additional $123,182 after 25 years. Fancy chart below:

Portfolio A Portfolio B
Initial Investment  $       10,000  $      10,000
Monthly Additions  $            500  $           500
25 years later  $     536,286  $    413,105


All of this strictly because you chose a 90/10 portfolio over a 50/50 portfolio. However, this type of decision doesn’t come without risk. In 2008 if you had Portfolio A you would have lost $32,776 instead of only $15,920 with Portfolio B.

The question you have to ask yourself is, can you handle dips like this without getting scared and pulling your money out of the market? In theory it is easy to say you’d be able to, but in reality it is a lot harder. While this example I showed it very simple in nature, I believe it shows a lot about risk in your portfolio. The riskier the portfolio, the greater the potential return.

While people have recommended asset allocations based on age, retirement dates, etc., it all comes down to how much risk you personally can afford/stomach in a time period.

So, to wrap things up (hell of a transition into a conclusion), be aware of how your asset allocation can help you reach your goals faster and make sure you can handle the bear markets when they strike with your current allocation.


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