Thursday 7 March 2013

Asset Allocation

When I first started investing seriously in the early 1990s, I read a few books and the almost obligatory Investors Chronicle and made a few notes in the back of my investment notebook. Some years later, after the dust had settled from the so called dot-com crash, I re-read my notes and began to understand the concept of asset allocation. At the time, like many other small investors, I had been sucked into the technology bubble of the late 1990s - all of my investments were equities and included a rather high proportion of tech shares.

Asset allocation is really a question of looking at the possible options and deciding what proportion of your investments to put in each one. The usual classes of asset are equities, government bonds (gilts), corporate bonds and fixed interest securities, commodities such as gold and silver, property and finally, cash.

A classic allocation is 60% equities and 40% bonds. My current allocation is 60% equities and 40% corporate bonds, pibs and fixed interest. There is no such thing as a perfect asset allocation - each person should decide on the best mix, and of course, the mix between different classes of asset can vary over time.

One rule of thumb is to hold the same percentage of bonds as your age - so at age 30 years, it would be 70% equities and 30% bonds. At age 50 years, a 50:50 mix etc.

Tim Hale, author of “Smarter Investing” suggests 4% in equities for each year you intend to be investing - the remainder in bonds.

Another popular choice is the Harry Browne Permanent Portfolio allocation - 25% equities, 25% gilts, 25% gold and 25% cash. The portfolio is rebalanced once per year to restore any imbalance that has arisen as one asset class does better than another.

Personally, I’m not a big fan of gold, mainly because it does not provide an income - other people will hold a significant percentage in their portfolio as a hedge against currency devaluation.

Whatever allocation you may decide is right for your investment approach, the main point is that you have addressed the issue. Also, I wouldn’t get too bogged down with 2% or 3% in this class and 4% in another - a broad brush is going to do the job and will be easier to manage and rebalance.

Many private investors start off with good intentions, but get sidetracked by the latest trend - with me it was technology shares in the late 1990s - but it could be smaller companies, emerging markets, commodities and so on, ending up with a dogs dinner of a portfolio.


If I were in my 20s or 30s, I could well decide to choose 100% equities, after all, they are the most likely to provide the best return over the longer period. This is asset allocation - its just that I have chosen to allocate 100% to equities. Obviously there will be no need to rebalance.

Say I choose 50% equities, 25% gilts and 25% corporate bonds - and say at the end of the year equities have done very well and have increased to 60 % of the total portfolio value. This would mean the gilts and corp. bonds represent only 40%. The idea of rebalancing is to restore the original balance of 50:25:25, therefore I sell some of my equities and reinvest the proceeds into bonds and gilts. The overall value of the portfolio has increased but the original allocation percentages are always restored at regular intervals.


One of the benefits of spreading your investments across a number of different asset classes is the reduction of volatility. If you are invested 100% in equities and there is a sudden downturn in the markets, you could easily lose 20% or 30% of the value of your portfolio in a very short period of time - witness late 2008! However, if your investments are mixed between equities, gilts and other fixed interest securities, it is more likely the loss will be more like10% or 15% which should make it a little easier to ride out the storm.


With an ever increasing choice of low cost trackers - funds and exchange traded funds (ETFs), it is relatively simple to select a range of products to provide you with a fully diversified asset allocation to fit every possible option.

Vanguard are very popular and offer a good range of equity and bond trackers Vanguard trackers . They also offer the increasingly popular LifeStrategy range ( here ) which combine equities and bonds in one fund according to the level of equity exposure you require - furthermore, the fund is automatically rebalanced on a regular basis.

For more info on the full range of low cost trackers see the latest update on Monevator here

Asset allocation is a mechanism for balancing the elements of risk and reward and is one way of ensuring an element of diversification - in a future article, I will look at other ways to spread risk.


  1. Hi John

    It looks like you've been really busy making some great posts over the past couple of weeks. It looks like blogging really agrees with you.


  2. Hello RIT,
    Thanks for dropping by - I was beginning to think the comments facility wasn't working. In fact I just had a message from MI to say he had been unable to comment but was being asked to select an account he didn't have!

    I've been enjoying putting the first few post together but don't think the 'post-a-day' will last for much longer - as you know, it takes quite a bit of effort to write even the most basic article!


    1. Hi John

      Hopefully I can help a little there. You are actually limiting who can Comment by the way you are set up. If you would like to open up the comments I would suggest you do the following:
      - In your dashboard go to Settings -> Post and comments -> set Who can comment? to Anyone
      - In the same place set Show Word Verification? to No. This was a tip from TI which really helped me open up my site.
      - You're now going to get more comments but at the same time you will now start to get Spam. I would therefore set Comment Moderation to Sometimes and then set a number of days. I use 7 days. This will mean anything older than 7 days will require you to approve before it posts thereby keeping old posts clean. You then just have to monitor the newer posts for Comments and delete the Spam.

      Hope that helps.


    2. Cheers RIT - I've tweeked a few of the settings for comments as suggested.

  3. Glad I could help a little. I've just commented successfully using the Name/URL option. I have however still had to use the Captcha feature. Did you mean to leave this enabled?

    1. Mmm.. just had my email account hacked today so thought it better to leave the spam filter and see how it goes.

  4. Hi John,

    Just a quick note to say well done on the new blog - the first few posts have been very interesting and I look forward to reading more!

    Thanks for opening up the comments also - it is much easier now :)


    1. Hello MI,

      Glad you've got through at last! Pleased to hear you are finding the posts interesting and looking forward to developing the site over the coming weeks.



  5. It's great to see a blog from someone who is walking the walk! I'll kick of the investment-related comments.

    I'm not convinced by the accepted wisdom of bond/equity asset allocation. especially not the proposal to increasing the % of bonds as you age. Not at all. I take the (crazy?) view that bonds at today's valuations have no place in an ultra longterm retirement portfolio. By ultra longterm I mean longer than my lifespan.

    Asset allocation seems concerned with avoiding volatility. For the record I strongly agree that the capital value of a 50:50 bonds:equities portfolio will almost certainly fall less in a bear market than a 100% equities portfolio.

    However, the asset allocation advice implicitly assumed that the investor intends to sell the portfolio at some future date. If you plan to buy an annuity then fine - i agree with increasing bonds as you approach annuity time. It would be madness to risk a 30% haircut on the day before you sell the portfolio to buy an annuity.

    However, what if the investor is unconcerned by volatility and has no intention of selling the portfolio? His share certificates are in the bottom drawer, and he cares only about the dividend income. What if he intends to live off the equity dividends and leave the portfolio in his/her estate on death. If that is the strategy then there is no reason to fear volatility.

    An asset allocation fan may well say that the income from the 50:50 portfolio is less risky in a market crash which savages the dividend income but not the bond income. To that i say that the bonds are the riskiest part of the portfolio because they savage the yield from day one.

    An equity income portfolio set up today would yield around 4% hopefully rising with inflation. Lumbering the portfolio with 50% bonds would lower the yield by around 25%. Furthermore the bonds would be a drag on future income growth because the bond income is fixed.

    Am i crazy? Comments most welcome.

    1. Hello Brodes and welcome to the site.

      I agree with the thrust of your comment - the investor who is investing for the long term and who is unconcerned with volatility could well do better in avoiding low yield bonds.

      I think my own view may be closer to Tim Hale's position of 4% equities for each year you intend to invest - at age 60, if you think you have a further 25 yrs, maybe 100% equities would be OK.

      I think the main thing is to address the issue and make an informed decision.

  6. @Brodes -- I'm inclined to agree with you that long-term bonds look unattractive here. However many investors -- not just older investors, but also those who might be scared by and do something silly because of volatility -- do IMHO need more than equities in their portfolio.

    I'd suggest a ladder of fixed-deposit savings accounts holding cash (and yielding c.3%) as a decent alternative for private investors. (I am working on a post on just this, in fact!)

    You have said 4% yield from equities, hopefully rising with inflation. Sounds reasonable. Keep in mind that you're actually asking for a 7% return, though (4% plus inflation) which is higher than many out there expect, although personally I think it's doable.

    1. Hi Monevator - thanks for dropping in and contributing.

      Looking forward to your article on savings accounts.

      I'm a bit confused about the 7% return and the 4% yield (- but then that could be down to the driving down the M6 in rain)!

  7. @Monevator

    I look forward to that post. However, I disagree that a 4% yield increasing at 3% per year is the same as a 7% return.

    Viewed from the perspective of an income investor who is not concerned with capital gain (remember the certificates in bottom drawer):
    In year 1 its a 4% return
    in year 2 its a 4*1.03 = 4.12% return
    In year 3 its a 4.12*1.03 = 4.24% return
    and so on

    In fact I would say that is a conservative return. All other things being equal, a company on a P/E of 10 could afford to pay out that dividend more than twice over. The retained profit can be reinvested in the business. In this case the company keeps 6% of the market cap as retained profit - to be invested to generate more cashflow for raising the divi. Assuming of course that managament don't award themselves massive bonuses or blow it on acquisitions/buybacks.

    1. @ Brodes

      Monevator is right but I see where you are coming from.

      You are quite rightly giving the dividend return on the initial amount. I think Monevator is looking at the total return.

      This is worked out by taking the initial dividend yield plus the expected dividend growth plus any change in the share price (usually estimated by the price to dividend ratio or dividend to price if you prefer).

      So lets say a share is expected to pay a 4p dividend with a yield of 4%. The share price will be 100p.

      If I understand correctly, if the market thinks this company can grow dividends at 3% it will forecast a payment of 4.12p as you say above. Assuming the stockmarket values the shares at a 4% yield, the shares will rise to 103p (4.12/4%).

      So in year 1 you will get 4p in dividend and a 3p gain in the share price. 7p divided by 100p is 7%.

      Roll forward another year. 4.24p/4% gives a share price of 106.09p. You get a dividend of 4.12p. Total gains of 7.21/103 is 7%.

      Congratulations DIY Investor (UK) on a helpful and well written blog.

    2. Hello Phil,

      Thanks for the detailed explanation on dividends.

      Thanks also for your good wishes and good to hear you think it is helpful.

    3. Hi John,

      Thanks for the hard work put into your blog articles. I've found them interesting and useful. Same goes for your ebooks too!


    4. Hello Dave,

      Appreciated, cheers