DIY Newbie - Step 1 (cont.) - asset allocation

To finish up with the asset allocation tool, let's take a specific example. We'll use these results in later posts. You may want to do this for your specific situation. The end result will help us set up an actual portfolio.

The assumptions we use for our specific example are as follows:
Age: 35
Current Assets: $100,000
Savings/year: $10,000
Marginal tax rate: 25%
Income required: 0%
Risk tolerance: middle
Economic outlook: middle

With these assumptions, we get 28% large cap, 19% mid cap, 14% small cap, 15% foreign stk. This represents the stock allocation. In total it is 76% stock.

On the fixed income side, we get 10% bonds, 0% municipals, 14% cash. In total then, the tool suggests 24% in fixed income.

A couple of comments are in order. As Grouch noted in an earlier post, there are "rules-of thumb" that are often used. He specifically mentioned Bogle's view that bond percent should equal age. Another more aggressive one is 120 - age equals stock position. One I recently came across is that stocks should be twice the loss that would make you uncomfortable. For example, if a 25% drop in your portfolio would get you to move aggressively to a defensive posture, you should have no more than 50% in stocks.

The bottom line is that asset allocation isn't as scientific as it can be made to appear. Go to 3 different financial advisors and you'll come away with 3 different allocations. The point is know yourself and constantly monitor your allocation. As many observers have noted, we all learned a lot about our risk tolerance in 2008.

In the next post, we'll take a look at a risk tolerance questionnaire just to get a flavor for the type of questions typically asked and to pick out the important ones.