Asset Allocation Funds

Assist in achieving ideal asset allocation.

Asset allocation funds are single mutual funds that allocate funds across a range of asset classes.

Examples of asset classes include cash, bonds, stocks, real estate, foreign currency, natural resources, collectibles, and insurance products.

The purpose of this asset allocation is to provide investors with truly diversified holdings and consistent returns.

This spares the investor the trouble of having to accomplish asset allocation by purchasing a large number of different funds.

Some asset allocation mutual funds have a specific breakdown of asset classes that they try to maintain over time, while others vary the composition as opportunities and circumstances change.

Asset Allocation Strategies

There are three basic types of asset allocation strategies based on investment goals, risk tolerance, time frames and diversification ...

  • a strategic asset allocation - has the aim to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon
  • a tactical asset allocation - involves a more active approach from the investor that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for gains
  • a core-satellite asset allocation - has the core of the portfolio consisting of passive investments that track major market indexes, such as the Standard and Poor's 500 Index (S&P 500), with additional positions, known as satellites, added to the portfolio in the form of actively-managed investments.

The Optimal Asset Allocation

The optimal asset allocation is very much dependent on where you are in your life cycle, whether you are working or retired, and what the nature of your near-term expenses might be.

Common asset allocation advice to determine your ideal asset allocation is to subtract your age from 100 to get your stock allocation. So a 20-year-old would put 80% of the portfolio into stocks, while a 65-year-old would have only 35% stocks.

The reason is that a 20-year-old can ride out even a long-term bear market. Once you retire, it's considered best not to have your whole investment portfolio exposed to stocks as cash may be needed to live on.

You don't want to be selling shares to fund day-to-day expenses when share prices are at rock bottom!

With people living longer, a 35% allocation to stocks is considered too low by some (and by me) as a longer anticipated life span provides a greater opportunity to ride out any downturns.

This assumes that you have sufficient funds in cash to live on in the meantime. I ensure that I have ready access to cash to fund living expenses for three years plus any major expenses anticipated in that time period.

The Vanguard Asset Allocation Fund

The Vanguard Asset Allocation Fund is an example of this type of fund. It seeks to maximize long-term total return (share price growth plus income) while incurring less stock-market risk than a fund made up entirely of stocks.

It follows a tactical asset allocation strategy and uses a computer model to evaluate expected returns and risks of stocks, bonds, and money market securities. The fund recommends changes in allocation among these asset classes as the return obtainable from each asset class shifts.

A Vanguard asset allocation chart provided by the Vanguard Group for various age groups, including for retirement asset allocation, can be accessed here.

Vanguard also offers an asset allocation calculator that helps to track asset allocation in Vanguard accounts, and to re-balance them. It can track asset allocation for more than one asset group across several Vanguard accounts.

To Conclude

From a value investing perspective, asset allocation funds can provide important diversification across asset classes. They also provide the capability of changing the asset allocation in each asset class over time.

Asset allocation charts for different age groups provide assistance in determining the optimal asset allocation over the investor's life cycle.

Fund providers also offer a range of funds to take into account risk tolerance, investment goals and time frames.

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