Life cycle asset allocation mutual funds are increasingly popular among those seeking single fund, buy it and forget it investment solutions.   

Right now the retirement target date funds are essentially the domain of mutual funds, but it is just a matter of time before they are also the domain of ETFs.

We have a number of substantial misgivings about the approach based primarily on the complete absence of investor specific information other than retirement date. 

For example, what a 50 year old retiree should do is probably different than what a 65 year old retiree should do.  What a wealthy retiree and a struggling retiree should do is completely different.  What a retiree with a pension income should do is not the same as what a retiree without a pension income should do.  How one retiree can cope emotionally with volatility is not the same as how another can cope.

Our concerns notwithstanding, we think it is useful to be aware of the allocation models used by leading mutual fund companies in their retirement target date funds.  Assuming that those funds represent conventional, “cookie cutter” thinking, it is good to know how your portfolio allocation compares to a ”one size fits all” approach to portfolio design driven soley by age or retirment date.

We reviewed the recommendations and actual fund allocations at T.Rowe Price, Vanguard and Fideltiy to produce the following composite average allocations by target retirement date (and implied current investor age based on an age 65 retirement).  

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The three organizations are reasonably tightly clustered, but T.Rowe Price is the more aggressive.  Vanguard is the more conservative.  Fidelity is in between.

One notable observation is that the domestic stock to foreign stock allocation in all of the portfolios is quite different than the actual world market capitalization.  The current U.S. stock markets are about 45% of world market capitalization, with the non-U.S. markets representing about 55% of world market capitalization — roughly a 1:1 ratio of U.S. to non-U.S. equities.

The average target date fund allocation within equities is between 3:1 and 4:1, U.S. to non-U.S. equities.

If you seek strong foreign exposures, you would not rely on the allocations used by the target date funds.   If you seek only mild foreign equity exposure, target date fund allocations may or may not be appropriate starting points for thinking about your asset allocation. 

If you want to absolutely minimize the complexity of your portfolio without squeezing yourself into a ”one-size-fits-all” fund solution, while at the same time maximizing diversification; and if you are happy with only a three asset class approach, you could develop your own reasonably suitable allocation using:

• VTI (to track DJ Wilshire 5000) for domestic stocks
• VEU (to track FTSE World ex US) for non-domestic stocks
• BND or AGG (to track Lehman Aggregate) for domestic bonds
• your money market fund of choice

Of course, you may might rather have additional classes in your portfolio, such as real assets and commodities and foreign bonds, for example.  And you might prefer to be more granular in some of the classes — one example being foreign developed country stocks and foreign emerging country stocks for your non-domestic equities. 

In any event, there is more than age and retirement date to consider in portfolio design and asset allocation.  We certainly design portfolios with more investor needs and circumstances in mind, as other thoughtful investment advisors would also do.

Richard Shaw
QVM Group LLC 

Disclosure:  Author owns VTI, VEU and AGG

The allocation of the typical 401-k plan probably fairly represents the asset allocation decision of the bulk of U.S. households.

According to a joint report by The Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) some 50 million Americans participate in 401-k plans which in the aggregate hold about $2.7 trillion in assets. 

At year-end 2006, about two-thirds of 401(k) participants’ assets are invested in equities through funds and company stock, and about one-third of assets are invested in fixed-income securities ranging from bond funds, to GICs to money market funds.

EBRI/ICI said that the 2:1 ratio of equities to fixed income has been changed little over the 11 years the study has been conducted.

These data cover people of all working ages, and a huge spectrum of incomes and other assets, but as a general statistic they represent the composite investment risk posture of ordinary people.

No individual investor should see this information as a model for their own portfolio, but it is interesting to know how your own portfolio compares in a general way to the composite saver/investor in the U.S.

Richard Shaw
QVM Group LLC

Real Estate:  It’s Up?, It’s Down?  It’s ……?

This week’s real estate price data is another example of why long-term investors should not be moved by short-term data or headlines.  Long-term investors should pay attention to long-term trends and ignore the daily fluctuations in the news for the most part.

Consider these two quotes, one from S&P Shiller-Case (via CNN) and the other from the Office of Federal Housing Enterprise Oversite (via WSJ):

CNN August 28, 2007 - “…Standard and Poor’s said its nationwide S&P/Case-Shiller Home Price Index fell 3.2% in the second quarter, compared with a year ago. … ‘The pullback in the U.S. residential real estate market is showing no signs of slowing down,’ Robert J. Shiller, chief economist at MacroMarkets LLC said in a statement. ‘The year-over-year decline reported in the 2nd quarter of 2007 for the National Home Price Index is the lowest point in its reported history, which dates back to January 1987.’ …”

WSJ August 30, 2007 -  “U.S. house prices appreciated 3.2% in the second quarter of 2007 from a year before, the Office of Federal Housing Enterprise Oversight (OFHEO) reported Thursday. …  OFHEO said prices rose only 0.1% in the second quarter from the first quarter, the lowest quarterly increase since 1994. … ‘House prices were basically flat in the second quarter despite tightening credit policies, rising foreclosure rates, and weakening buyer sentiment,’ OFHEO director James Lockhart said. ‘Significant price declines appear localized in areas with weak economies or where price increases were particularly dramatic during the housing boom.’…”

The two releases report exactly opposite direction and magnitude of housing price changes.  They are probably measuring different segments of the housing world, but they report the numbers as national aggregates and the investment news services report them as headlines that lead to nothing but confusion.  How frustrating. 

On Tuesday house prices were down year-over-year, but on Thursday they were up year-over-year.

Which reporting organization should we rely upon?  On what basis would we decide?  Best to discard both and wait for more confirmatory data from other sources over longer periods of time.

Not only is short-term news and data more noise than useful information, it is also replete with opposite interpretations of the same reality.  If short-term data were accurate and reliable, and it often is not, it would still relate to the real long-term story as noise, just as volatility relates to  real long-term price trends as noise.

We are in no way suggesting that all is well in the housing world.  We are suggesting that the value of listening to immediate news releases is greatly in question as illustrated by these two reports, one or both of which must be wrong. 

It is much better to take in all the news over a reasonable length of time to gain perspective and then put together a considered view of what’s really going on.  That prevents knee-jerk reactions and the whipsaw investing that results.

This week’s conflicted housing price data is a case in point —  so conflicted and so noisy that it must be fully discounted. 

You may have your own beliefs and/or facts about what’s going on in the housing world, but it sure would be tough to do much with the two opposite price data reports released this week.

Keep looking ahead and examine the full range of your direct and peripheral vision as you walk the path of investing.  Only then will you understand where you are going. 

You will see meaningful obstacles and hazards in perspective and in plenty of time as you approach them.  Watching only your feet as you walk will not inform you about the road ahead, and the daily news as your primary information source will not inform you about the investment road ahead. Watching your feet may actually cause you to stumble. 

Keep the long view as much as possible.

Richard Shaw
QVM Group LLC