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Portfolio Allocation – Part 2 March 11, 2007

Posted by pf in Portfolio Allocation.
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As I continued my research into various asset allocation methods and tools, I came across one calculator from Principal Financial Group that I found to be pretty interesting (Principal Asset Allocation Tool).

While the tool is relatively straightforward as far as inputs, what I found to be a bit unique was the fact that is runs a portfolio simulation with 500 trials to provide you with an expected portfolio based upon both your current allocation and also a suggested one.  Further, it gives you ranges of these outcomes within an expected confidence interval.  Finally, it does a really good job explaining some of the assumptions they used in their calculations (ex: salary adjusted for raises, any social security income included, etc)

You will notice the tool classifies investments as “stable” or “aggressive”.  They have a worksheet that uses more familiar terms (small-cap, large-cap, etc.) that then converts it into these classifications.  This way, you can know how each type of investment is categorized (ex: International = “Dynamic”)

Below are the key elements from my report: (Please note I could not copy / paste all the graphs here and make it show)

YOUR REPORT

After running 500 different scenarios, we found that some of these scenarios resulted in running out of money before you reach age 92–if portfolio assets remain allocated as they are today.  We also found that many of these scenarios resulted in success after reallocating portfolio assets.

Percent of Scenarios Resulting in Success

Current Portfolio – 87%

After Reallocations – 91%

Details91% of the scenarios resulted in not running out of money before PF’s age 92.Based on your portfolio after reallocation:

  • 5% of the scenarios resulted in running out of money before PF’s age 86.  
  • 8% of the scenarios resulted in running out of money before PF’s age 90.
  • 9% of the scenarios resulted in running out of money before PF’s age 92.

Asset Allocation Comparison

Your current allocation:

     
Asset Class Market
Value
% of
Assets
Stable $0 0.00%
Conservative $18,000 8.37%
Moderate $129,200 60.09%
Aggressive $8,550 3.98%
Dynamic $59,250 27.56%
 
Total Assets $215,000 100%

Based on your risk tolerance and time horizon, consider reallocating your assets to Growth Model IV:

Asset Class Market
Value
% of
Assets
Stable $0 0.00%
Conservative $32,250 15.00%
Moderate $86,000 40.00%
Aggressive $43,000 20.00%
Dynamic $53,750 25.00%
 
Total Assets $215,000 100%
     

To reallocate your current portfolio:

  • Add $0 to Stable funds
  • Add $14,250 to Conservative funds
  • Remove $43,200 from Moderate funds
  • Add $34,450 to Aggressive funds
  • Remove $5,500 from Dynamic funds

Asset Allocation Comparison (cont.)

Ranges your portfolio account balance might fall between at your expected beginning and ending retirement ages:

This means you should be 90% confident that with your current asset allocation:

  • At age 62 your portfolio account balance will be between $2,582,036 and $12,577,934. The median value of the scenarios was $5,714,373.
  • At age 92 your portfolio account balance will be between ($7,727,450)* and $157,349,484. The median value of the scenarios was $21,734,121.

And, you should be 90% confident that with the portfolio reallocated as shown previously:

  • At age 62 your portfolio account balance will be between $2,657,192 and $12,709,945. The median value of the scenarios was $5,974,196.
  • At age 92 your portfolio account balance will be between ($5,148,606)* and $158,997,208. The median value of the scenarios was $25,043,820.

Data Input & Planning Assumptions

Assumptions
Social Security payments:  Earnings

 based

Annual Social Security increase: 4%
Estimated annual Social Security amount (today’s dollars)*:    $21,174
Annual salary increase: 4%
Annual income need increase after retirement: 4%

Assets

Asset Classification Current
Market
Value         
Additional
Monthly
Deposits
Total Stable investments:  0   0
Total Conservative investments:   18,000   0
Total Moderate investments: 129,200   1,700
Total Aggressive investments:     8,550   0
Total Dynamic investments: 59,250   0

Although I did not include it here, the last section is the “How the Retirement Simulation Analysis Works”.  As I mentioned earlier, a very nice supplement whereas most of the other tools I’ve come across thus far left me wanting in this respect.

 I ran the simulation twice.  The first time, it showed me at 100% funded, and the second time are the results I’ve posted below.  I’m guessing if you ran it enough times, you would get a fairly consistent range of outcomes.  As so much of this is exercise requires various assumptions about the future (future income, investments, etc) I do not expect to come up with the “perfect” allocation, but should provide directional guidance at the level I had outlined in my previous post.

Although I am not going to post it here, I did look at other tools as well and found more similarities than differences.  Based upon the information I have been able to gather, I think I have come up with some rough guidelines for a proposed allocation:

Category Current Proposed Change
Bonds 8.62% 10.00% 1.38%
Small-Cap Growth / Value 3.91% 10.00% 6.09%
Mid-Cap Growth / Value 5.52% 10.00% 4.48%
Large-Cap Growth / Value 45.41% 34.75% -10.66%
Large-Cap Capital Allocation (PRWCX) 8.39% 10.00% 1.61%
International 27.59% 25.00% -2.59%
Individual Stock (PRU) 0.55% 0.25% -0.30%
Total 99.99% 100.00%

I don’t know if I would call this dramatic, but interestingly, it is along the lines of the allocation being proposed by the calculator from Principal.  In addition to the allocation tools I’ve looked at, there are some other drivers that are guiding my overall thinking:

1) I believe the long term potential for equities outside the US is great and I want to maintain 25-30% of my portfolio here.  I’m pretty firm here.

2) As my portfolio grows, I find myself attempting to mitigate some of the downside without giving up too much upside.  This is where bonds and the capital allocation categories come in.  I continually struggle with this one as I don’t want to give up any potential gains.  However, I do feel the current bull market is “long in the tooth” and am anticipating swings like the one we experienced recently.  Maybe this is just market timing and I should shy away from that.  At the same time, I think it’s consistent with my goals / tolerance for risk.  I expect this item will continue to occupy my thinking.

3) Small / Mid-Caps – In some cases, I do feel they are getting expensive.  For example, you’ll notice my Mid-Cap Growth (RPMGX) has only a pittance in it. I used to have a larger stake, but at a P/E of 22+, how much more upside is there?  The only reason I keep anything in there is because the fund is closed to new investors and I don’t want to lose the ability to invest in that fund (which has historically done very well).  My current weightings driven by this thinking, but long term, I think the proposed mix is where I want to be.  

What I’m a little bit unsure about is timing.  Should I go ahead and do it all in one go or gradually over time (via my future investments).  I’ll ponder this a bit and share my thoughts in a future posting.

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