Figure 1: SmartMoney logo
SmartMoney magazine was one of the leading investment periodicals from 1992 to 2012. It was rare after reading it, we didn’t learn at least one new piece of information from each monthly publication. Sadly, when MarketWatch bought it out in 2013, they never really did anything with the paper publication nor its robust website.
If one is willing, they can find some old references to SmartMoney on the Internet, and still glean some good information. It is from their collective work we developed an asset allocation spreadsheet that at least starts a conversation on how one should divide up their investment dollars. This is important. As Brinson, Hood, and Beebower wrote in 1995, an investment philosophy explains, “on average 95.6 percent of the variation in total plan return.” They add, “Although investment strategy can result in significant returns, these are dwarfed by the return contribution from investment policy—the selection of asset classes and their normal weights.”
If one wants to find the spreadsheet we have developed based on the examples from SmartMoney, here is the link for it. Once you get to the sheet, you will be asked some basic questions.
Age-Quite possibly, the most important factor in determining one’s allocation mix. The reason is that the value of time is the most important asset one has. We, though, added an additional component to the question. It is, “When do you need the money?” We felt it was necessary, since some investment plans are not retirement plans. These, obviously, include plans such as 529 college savings plans.
Given that one’s time horizon is so important, we want to make a note that during no 20-year period has the S&P 500 ever suffered a loss. That is not say it can’t happen, but we felt that if one is investing for a period greater than 20 years, then it would make sense for them to avoid fixed-income investments, depending on their risk tolerance.
Portfolio Size-Given that 17 years a long time since SmartMoney came out with their initial ideas, we modified the question to reflect the potential increase in portfolios since then. What were then levels of $50,000 and $250,000, we changed them to $100,000 and $500,000. The size of one’s portfolio is important because, “The less you have, the more you need to exercise caution.” Also, if one’s pie is not very big, it is hard to put a lot of slices in that pie. Eventually, SmartMoney asked how much of one’s portfolio was in tax-deferred accounts.
Yearly Savings-We changed the numbers to reflect the new limits one may contribute to an IRA ($6,000) or a 401k/403b ($19,000). The more one is able to contribute, the more one is able to tolerate risk
Spending Needs-Originally, SmartMoney only asked about spending needs for the next ten years. Eventually, they also asked about the spending needs for the next three years. They also added questions about the number of dependents in the household and how much equity one has in their home. These were welcomed additions.
Investment Income-This was a question asked in the original format. Investors who need income would require a more conservative portfolio. Meanwhile, those were still in the accumulation phase would seek out more growth. This question was eventually dropped, and replaced with the spending need questions mentioned earlier.
Federal Tax Bracket-The reason this question is being asked is because, “the higher the tax bracket, the more you want to avoid distributions such as dividends and bond coupons while your investments grow.”
Volatility Tolerance-One needs to ask themselves how they would react in the event of a market downturn. It is a difficult question to answer, and too often asked too late when a massive correction has already started. Take a look at the next chart, and use it to determine your level of volatility tolerance.
Median Annual Return
Figure 2: Hypothetical Returns
We always suggest to investors that they look long and hard at that last column, and answer the question about their level of tolerance. Numbers are theoretical, until they become real.
Economic Outlook-The original format had only three levels: Weak, Average, Strong. Later, SmartMoney added two levels of “Strong,” and a “Don’t Know” option. One should focus where we are in the business cycle, and also pay attention to the financial news that is occurring. Our take right now is that we will see anemic growth in the next 12 months.
Interest-Rate Exposure-This was a question that answered itself based on the answers to the remaining questions. The theory then was to make sure one was not overexposed to bonds and large cap equities in a potential rising interest rate environment. It has been maintained as part of the process since then. Our feeling is that one should either adopt a bond ladder or a bond barbell approach.
As mentioned before, we adjusted the age factor by also asking when the money was going to be needed. We also made additional enhancements.
Mid-Cap Stocks-We have never liked the way asset allocations define domestics stocks as either Large or Small. We adjusted to account for companies that occupy the middle space of the market cap spectrum.
Foreign Stocks-The original formats made no distinctions between foreign stocks from developed countries (EAFE), and those from emerging markets. We do, splitting our foreign investments between these two categories with emerging market stocks making up 40% of international holdings.
Specialty Investments-In 2002, there was no accounting for specialty investments such hedge funds, REITs, and commodities. We made those enhancements so those who might be interested in those categories, can allow them to be part of their overall allocation.
Diversified Bonds-In this low interest environment, we believe one should allow for high-yield investments, and debt from emerging markets. There are some wonderful instruments that will allow one access to these kinds of investments.
Other Enhancements-We also recognize that investors cannot access their retirement accounts until they turn 59 ½. Also, when one chooses to be aggressive, including not holding any fixed-income investments at all, the portfolio should reflect that. Finally, we added an additional component to the spending needs question where if one says they do not need any money soon, they are given that as an option.
We need to state that all the enhancements we have added make for slightly more aggressive portfolios, so if one needs to, make adjustments based on what you need.
Putting It Together
Here is a sample of what an allocation might look like for a sample investor based on the earlier version and the enhanced version.
We have an investor who has less than $100,000 invested for retirement; most of it in an old 401k. They are 50 years old, and invest $7,000 per year, knowing they need to take advantage of the catch-up provision. When they turn 65, they hope to retire, so they know they need to get busy. They have no dependents. They earn a decent income, and have equity in their home. While they will accept some risk, they are nervous about the current economy. They admit they do not know enough about any specialty investments. The original 2002 version of the questionnaire would have suggested this allocation:
Figure 3: Original SmartMoney Allocation
As one can see, this provides a very vanilla asset allocation. We are also struck by how conservative it is, even for a moderate investor who needs to grow their portfolio by the time they retire. This version has our investor allocating 49% of their portfolio in fixed income. Of course, that was when fixed income paid better interest rates than what one sees today.
Here is what the enhanced allocation calculator gives us:
Figure 4: Enhanced Sample Allocation
Our investor sees that they need to allocate 29% of their money in Cash & Cash Equivalents and Bonds, not 49%. As the illustration shows, the remaining 71% is reserved for equity investments. They should perform their own enhancements as they see fit. For example, if they see no need for Cash, they can invest in short-term fixed income instruments. We feel that this is a more appropriate approach in this low interest rate environment.
Since our goal is to be more educational, we are also learners, so feel free to provide any feedback.
Here are the links to the two spreadsheets used for this article:
Feel free to download these, and use them as you wish.
We have seen many theories regarding asset allocation. Dave Ramsey famously stated put all of one’s investments in four equity mutual funds, and skipping bonds. We don’t recommend that. Mr. Ramsey is right about one thing, though, “Invest some freaking money!” The key to these instruments, as well as many others, is to explore oneself and determine their relationship with their money. As always, we recommend that you meet with a financial advisor, and have a good conversation with them about this topic.
We also provide more options that what is normally provided with many asset calculators. We have not seen too many that allow for REITs, commodities, and hedge funds in their calculations. We feel it is important to have these as viable options. We hope you like them.
Good luck out there.
- Past performance is not an indicator of future performance.
- This post is illustrative and educational and is not a specific offer of products or services.
- We are using this blog to test ideas and learn from the Seeking Alpha community.
- Information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein.
- Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed.
- All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change.
- Investments in individual sectors or companies may be more volatile than investments that diversify across many industry sectors and companies.
- Certain sectors of the market may expose an investor to more risk than others.
- Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
- Dividends can be reduced or eliminated at any time.
Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. 1995. "Determinants of Portfolio Performance." Financial Analysts Journal 133-138.
FreeDigitalPhotos.net. 2015. "Allocation Allocate Means Give Out And Delivery." 100274522. March 7.
Huang, Nellie S., and Peter Finch. 2002. SmartMoney Stock Picker's Bible. New York: John Wiley & Sons, Inc.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.