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.
Think that was their reaction?
Actually, it was more like this:
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.
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?
- You probably like words like frugal, saving, budget, wealth, side-hustle, money.
- These words are how you make money.
And I know you like making boatloads of money. You’re reading this.
- You should also like the words diversify, risk, and asset allocation.
- 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.
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?
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 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.
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:
- across asset class
- Don’t put all your cash into 1-2 stocks and 1-2 bonds.
- 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.
- across markets
- Don’t invest in only U.S. stocks and U.S. government bonds.
- Do put some of your money in foreign stocks (Europe, Austraila, Far East index, etc…you can do this through index funds too!)
- across time
- Don’t just save money in a savings account, and then buy stocks/bonds all at once, in huge bulk amounts
- Do invest periodically (and consistently) in small chunks.
Don’t try to time the markets. Take the guesswork and stress out of investing.
“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 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.
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.
- See the 3 bullet points above. These all but destroy risk.
- Choose a formula below, based on your self-assesment of risk
- this involves your age, risk tolerance, and attitude on losing money
- this will change over time (hence the importance of rebalancing your portfolio)
- 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:
- Billy Joel – low risk
- The Beatles – medium risk
- Ozzy Osbourne – high risk
(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:
- super low cost
- 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…
- has a full-on retirement planner, because you are a bit older, or
- 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?
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.
- Contribute regularly to your investment accounts. Put it on autopilot so you don’t have to think about it!
- Invest in international stocks/bonds as well. This is a nice safeguard against our crazy economy.
- Use index funds. Fees matter a TON, and your money is inherently diversified.
- 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
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.