Asset Allocation Models 101: how to NOT lose money

The 2016 ultimate guide to NOT losing money in your investments

As it turns out, monkeys are who we should study to learn why asset allocation models are so important.

A group of monkeys are hanging around (snicker) their zoo cage one day, when the group of researchers begin their test.

The researchers walk right up to their furry counterparts and give each monkey one single apple.

Because monkeys love apples, they were absolutely thrilled.

But for part 2 of the experiment, the researchers went to the monkeys and gave each monkey two apples each! However, the researchers immediately took one apple back away.

monkey learns asset allocation

Think that was their reaction?

Actually, it was more like this:

asset allocation models

The monkeys were furious, despite the fact that they still ended up with the exactly same amount of apples as part 1 of the experiment.

We act the same way, don’t we?

We’ll often be more upset after losing something we’ve had….rather than never having it in the first place.

(side story: About 7 months ago I found a $20 bill in an old sweatshirt. I was thrilled….promptly lost it…and was pissed. Research confirmed.)

Enough monkeying around. Losing money sucks.

Bonus: The post is uber long, with tons of resources, links, how-tos, etc. How’d you like to take a free, 5-day video course and master this subject? Grab it here.

5 days to investment mastery.

First things first: the single best piece of investing advice for the average human being

Use index funds like they are going out of style (because they’re not).

I’ve already shown you WHY index funds are the way to go here and here…but honestly, this post by Mr. Money Mustache, “How to make money in the stock market” does a far better job than I ever could. It’s one of the most popular personal finance articles of all time.

If you haven’t read that, go read it right this second.

This post presents the answer to ‘not losing money’ in your investments. It’s called asset allocation.

You probably read personal finance blogs, yes?

  1. You probably like words like frugal, saving, budget, wealth, side-hustle, money.
  2. These words are how you make money.

And I know you like making boatloads of money. You’re reading this.

  1. You should also like the words diversify, risk, and asset allocation.
  2. These words are how you keep your money.

Quite frankly, this shit matters more than you think. Here’s all you need to know:

The 3 types of diversification
The truth about risk
The super-secret magic formula of asset allocation

Why is losing money even worse than I thought? Solve this math problem.

You are a monkey with a huge stash of apples and bananas, going to town with your new tool (bought based on the amazon reviews…)

However, a bear breaks into your cage, and steals 50% of your entire stash.

Question: how much do you need to make back, to return to even?

50%? Nope.

You need a 100% return to get back to even. This is an important concept.

(a realistic example: You have $100,000 in savings, and lose 21% in the crash of 2008. You now have $79,000. In order to get back to $100,000, what percentage increase do you need?

You now need a 26.5% increase to break even.)

Most monkeys fail to realize why losing their stash is so bad. It becomes much harder to recoup your losses in the same market.

Remember that guy Warren Buffett? His rules for investing are quite clear.

i think he knows what he's doing?
i think he knows what he’s doing?

I rest my case, now let’s learn how to NOT lose money, and show you the stupid simple asset allocation models.

The 3 types of diversification

If you’re reading this far into this blog post, I’m going to reward you with a new style of personal finance blogging that you’ve never seen before.

There’s lots of juicy links, resources, and quotes down below in this post….and all of that is great. All of that stuff contains the reasons behind why you should do this or that.

But this next part is inspired by the great Derek Sivers (from this episode of the Tim Ferriss podcast). 

No learning required. I’m going to tell you what to do.

Is it presumptuous? Absolutely. Is it the easiest way to teach people how to avoid losing money with their investments? Absolutely.

Here’s how to master the 3 types of diversification, and lower your chances of losing money:

  1. across asset class
    1. Don’t put all your cash into 1-2 stocks and 1-2 bonds.
    2. Do spread your investments out with a few commodities (like gold), real estate, large-cap stocks, small-cap stocks, short-term bonds, long-term bonds, and throw in some other notes and securities if you like.
  2. across markets
    1. Don’t invest in only U.S. stocks and U.S. government bonds.
    2. Do put some of your money in foreign stocks (Europe, Austraila, Far East index, etc…you can do this through index funds too!)
  3. across time
    1. Don’t just save money in a savings account, and then buy stocks/bonds all at once, in huge bulk amounts
    2. Do invest periodically (and consistently) in small chunks.

Don’t try to time the markets. Take the guesswork and stress out of investing.

From fellow PF blogger Mrs. Frugalwoods:

“You’ll drive yourself nuts if you try to pick the perfect moment to start investing–much like brushing your teeth every day, it’s something you should do regularly and without fear or drama (unless you have some sort of bizarrely dramatic oral hygiene routine).

Investing is a long-term proposition–it’s not something to track or speculate about on a daily, or even yearly, basis.”

the smarter dollar asset allocation
Vanguard’s international index funds. so. friggin. easy.
Bonus: If you want to know more about why to diversify in these ways, including what the hell “dollar cost averaging” is and how it makes you $$$$, grab the free video series here..

The truth about risk

is that you have less of a tolerance for it than you think.

In his 2013 letters to shareholders, poor-dude Warren Buffet mentioned he instructed one estate to have the following portfolio makeup:

  • 90% low-fee stock index fund
  • 10% short-term government bonds

Wait, what the frick?

“90% of my money in stocks?? Is that dude cray-cray??”

Yes and no. The point Buffet was making is that index funds are completely amazing, and that for the right person this is still a solid long-term investment strategy.

Note the words ‘for the right person.’

Most of us monkeys don’t have the stomach for that kind of volatility, or the patience.

  • Do you fear being poor?
  • Do you dread living paycheck to paycheck?
  • Do you worry about living far beyond your retirement funds?
  • Which would you prefer: happiness and 4.5% a year? or absolute misery and 8% a year?

Think about that last question again for a second.

You already know that “everyone’s risk tolerance is different.” You’ve heard this before. But why is that?

Because risk is a mentality.

Historically, I’ve been extremely risk-adverse. (I’m getting bolder.) Figuring out your own risk tolerance involves examining how you feel.

so much scared

Here’s a few handy questions on risk.

  • Seriously, how would you feel if you lost 15-30% of your net worth tomorrow?
  • Seriously, how much does 10% of your retirement account mean to you. Is that $20k or $200k?
  • What would losing that amount feel like? Life or death? Who cares I have millions left?

Once you have been 1,000% honest with yourself and discovered your true risk tolerance mentality, here’s what to do with your risk.

  1. Diversify
    1. See the 3 bullet points above. These all but destroy risk.
  2. Choose a formula below, based on your self-assesment of risk
    1. this involves your age, risk tolerance, and attitude on losing money
    2. this will change over time (hence the importance of rebalancing your portfolio)
  3. Rebalance
    1. Your risk tolerance is way different at age 64.5, than at 31. Rebalancing is mandatory

So what’s your deal?

Are you Ok to go 90% in stock index funds?

Or will you sleep better at night knowing that a stock market crash in the next year isn’t going to force you to work an extra 5 years before retirement?

The super secret magic formula for asset allocation strategies

We’re going to take some advice from BudgetsAreSexy, and keep this stupid simple.

  • You being overwhelmed = bad.
  • You leaving my site and actually taking some sort of action = better

Let’s give 3 options based on your age/risk tolerance, and let’s quantify with rockstars:

soft rock

  1. Billy Joel – low risk
  2. Coldplay
  3. The Beatles – medium risk
  4. KISS
  5. Ozzy Osbourne – high risk

death metal

(Random note for Canadians! Just read this awesome post from Money After Graduation and thank her.)

You can select these in your 401k’s, 403b’s, IRA’s, or just open a free account and grab some low-cost investor shares.

Without further ado, here are some copy & paste asset allocation models.

Option 1 – for young people, or those who are legitimately aggressive and fearless about the future.

  • 60% Vanguard Total Stock Market Index (VTSMX) – KISS
  • 25% Vanguard Total International Stock Index (VGTSX) – Ozzy Osbourne
  • 10% Vanguard Total Bond Market Index (VBMFX) – ColdPlay
  • 5% Vanguard REIT Index (VGSIX) – KISS

Copy and paste people. Like Mr. Money Mustache, I prefer to go all Vanguard index funds because of 3 things:

  1. super low cost
  2. insta-diversification
  3. super low cost (remember this post?)

Option 2 – for everyone, everywhere, all the time. This is roughly the “all-seasons” approach from Tony Robbins’ monster book on money.

  • 40% Vanguard Long-term bond index (VBLTX) – The Beatles
  • 15% Vanguard Intermediate-term bond index (VBIIX) – Coldplay
  • 27.5% Vanguard Total Stock Market Index (VTSMX) – KISS
  • 5.5% Vanguard Mid-cap index (VIMSX) – Ozzy Osbourne
  • 3% Vanguard Small-cap index (NAESX) – Ozzy Osbourne
  • 6% Vanguard Total International Stock Index (VGTSX) – Ozzy Osbourne
  • 3% Vanguard Emerging markets stock index – (VEIEX) – Ozzy Osbourne

I can hear you through the internet right now.

“What is this? Am I suppose to memorize this?”

Of course not, but if you truly want to maximize your earnings over the next decade or more, while limiting your exposure to loss…then there you have it.

The allocation is based on modern portfolio theory, and this particular breakdown is similar to the “all seasons approach” in Tony Robbins’ Money: Master the Game.

(note: Tony also includes 15% in gold and other commodities. If you really want to learn about that, read the book. Else use index funds, and spend that extra time fishing with your kids, or reading this blog)

Option 3 – for those over age 55ish, or those who have no cajones less risk tolerance.

(note note note: This is not for those of you who are in retirement, or 1-2 years away. Go Google fixed-income annuities and TIPs)

  • 60% Vanguard Long-term bond index (VBLTX) – The Beatles
  • 20% Vanguard short-term bond index (VBISX) – Billy Joel
  • 10% Vanguard Total Stock Market Index (VTSMX) – KISS
  • 6.5 Vanguard TIPS index (VTIPX) – Billy Joel
  • 3.5% Vanguard Total International Stock Index (VGTSX) – Ozzy Osbourne

I don’t think anyone anywhere should use this. You are either the type of person that…

  1. has a full-on retirement planner, because you are a bit older, or
  2. doesn’t really care that much.

Just being honest.

BONUS asset allocation model for lazy people:

  • 60% Vanguard Total World Stock Index (VTWSX) – KISS
  • 40% Vanguard Total International Bond Index (VTIBX) – ColdPlay

This is so lazy. So low cost. So effective.

Sure, there’s not a ton of asset class diversification, but you’re lazy, and you’re still in it for the long game, right?

Conclusion

Here are the takeaways, summed up nicely in pink font so you’ll notice it on your screen, since you skipped half the content above.

  1. Contribute regularly to your investment accounts. Put it on autopilot so you don’t have to think about it!
  2. Invest in international stocks/bonds as well. This is a nice safeguard against our crazy economy.
  3. Use index funds. Fees matter a TON, and your money is inherently diversified.
  4. Losing money KILLS your bottom line. Want more money? Lose less money.

The more complex you make your finances, the worse off you’ll be. – Mrs. Frugal Wood


Want the full asset allocation models PDF and videos?

You should probably sign up for the new email course:

5 days to investment mastery.

5 days to investment mastery

It’s 5 minutes a day for 5 days, and covers the skeleton of a highly lucrative and smart investing strategy.

Oh, and it’s completely free.

Grab it here.

*

How to choose investments like Super Mario

Top retirement mistakes explained on a 3rd grade level – Part 3

This is part 3 of The Biggest Retirement Mistakes explained on a 3rd grade level. Part 1 here. Part 2 here.


Admit it.

Thinking about retirement is boring.

We’re in the now generation. We like instant gratification. We want to hustle and make fat stacks of cash now!

Retirement planning & saving money is pretty much the opposite.

fat stacks the smarter dollar
fat stacks mr. white

Building wealth is only hard because it usually requires delayed gratification, which we hate. (tweet this!)

Even if you’re trying to start a business and explode income growth, that takes delayed gratification too.

That said, what you’re about to read is an extremely important concept.

Internalize this point immediately and do something about it (aka take action in real life, not just Facebook share “cool post bro”)…if you commit to the concepts below, you will have more cash down the road.

That’s what you want right? Fat stacks of cash?

Think in longer terms. I know you don’t want to, but do it anyways. Unless you tragically die before your time (I witnessed this happen yesterday I’m sad to say)…then you will live to see the fruits of your efforts.

And how are your efforts going?

Are you going to thank yourself 20 years from now? Or wish you had saved dollars smarter?

Too lazy to spend 7 minutes reading this? Here’s a 3 min video summary, as well as 3 bonus videos on how to diversify! Grab it here
Continue reading “How to choose investments like Super Mario”

Why you’ll never beat the money system

Top retirement mistakes explained on a 3rd grade level – Part 2

The money system.The game. Banks. Retirement accounts. Stocks & Bonds. Capital gains. Interest.

First off, my apologies.

This wasn’t in the original plan for the mini-series on retirement planning. This post falls into the “things everyone should know but nobody actually knows” category.

You’ll enjoy the interruption though.

steve c

Many of you who read my blog are really into making, saving, and investing money (shocker). And I’m thankful for that. It’s a fun game most of the time.

But you need to get one thing straight, right now:

This is a long-term game, like it or not.

The problem

You’re in the “now” generation. You probably already understand this.

Due to the speed at which communications and interactions happen now, we’ve grown very fond of instant gratification. We’re incredibly inpatient in so many aspects of our lives. We want results now.

But when it comes to money, you need to calm the hell down. Continue reading “Why you’ll never beat the money system”

Top retirement mistakes explained on a 3rd grade level

This is part 1 of a multi-part series: Top Retirement Mistakes explained on a 3rd grade level.

401k’s. 403b’s. These are awesome tools that are leading you to a smooth, comfy retirement, right?

Not really.

If you’re employed, you probably have a retirement account, even if you don’t contribute a whole lot.

But what’s in that account? Stocks? Bonds? Do you even know?

What are your returns? What are your fees? Do you care?

(I’m going to crush your dreams of making money through tax-deferred plans, mutual funds, and stocks and bonds. I’m going to crush them. Here’s an intro video…)

To kick things off, let’s walk through the system that you have your money in.

Here’s your newbie learning tidbit for today: what do financial people mean by “the market?”

“The market” is just a medium of exchange. People buy and sell stuff. The stock markets go up and down. The housing markets go up and down.

But let’s think of it like a farmer’s market.

Continue reading “Top retirement mistakes explained on a 3rd grade level”

73 readers’ top financial problems and how to solve them

Money stress. Financial problems. I have em. The readers of this blog certainly have em.

“Socrates said ‘know thyself.’ I say, ‘know thy users.’” – Joshua Brewer, Twitter


 

First, your financial situation in life is like a money tree:

financial problems money tree

Sometimes your money tree is blooming, sometimes withering. Maybe your neighbor’s money tree is larger than yours. Maybe your money tree is still a seed.

The purpose of The Smarter Dollar has always been to help you grow your money tree. And in order to help your money tree thrive, we have to examine the roots and look at the causes of success and failure.

So, a few weeks back I emailed 236 of you and asked this question:

“What’s your biggest frustration about money?”

I received 73 responses, and I was expecting a bunch of different answers, such as:

  • “putting my kid through college.”
  • “I can’t quite figure out how to start a business.”
  • “I stress over paying bills every month.”
  • “I can’t figure out how to _______.”
  • “debt is eating my money tree.”

Sounds logical right? Apparently not. Continue reading “73 readers’ top financial problems and how to solve them”