Investing - Asset Allocation - Part 4

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Editor's Note: This post was published at the Carnival Of Investing #62 - The Oscars of Investing and was awarded the Oscar for "The Best Special Effects (Technical Explanation)". We thank you all.

[Continued from Investing - Asset Allocation - Part 3]

Static Models of Asset Allocation

In part 1 we have familiarized ourselves with the basics of asset allocation along with 2 very useful and interactive asset allocation calculators. In part 2 we described suggested models from Fidelity and Charles Schwab; in part 3 we looked at Etrade. In this mini series, today we shall explore static models of asset allocation from Vanguard.
4. Vanguard: The models given below are classified into three categories: Income, Balanced and Growth. Those of us who have at least 20 years available for investing before target retirement age may find the Growth models interesting. Balanced models may be more suitable to those who are within 5-20 years of retirement age. Income models would appeal to those who are on the verge of retiring or are already in retirement. As always please analyze your individual situation carefully and then choose a model that is most appropriate.

Each of the asset allocation models depicted below also show the average annualized return, its best and worst years of performance and total number of years the portfolio would have posted a loss. Historical data has been considered for the period 1960 to 2005.
Income - An income-oriented investor seeks current income with minimal risk to principal, is comfortable with only modest long-term growth of principal, and has a short- to mid-range investment time horizon.

0% Stocks, 100% Bonds
100% bondsAverage annual return: 7.1%
Best year (1982): 31.1%
Worst year (1969): -8.1%
Years with a loss: 5

20% Stocks, 80% Bonds
80% bonds / 20% stocksAverage annual return: 8.0%
Best year (1982): 28.8%
Worst year (1969): -8.2%
Years with a loss: 5

30% Stocks, 70% Bonds

70% bonds / 30% stocksAverage annual return: 8.4%
Best year (1982): 27.6%
Worst year (1974): -8.6%
Years with a loss: 5

Balanced - A balanced-oriented investor seeks to reduce potential volatility by including income-generating investments in his or her portfolio and accepting moderate growth of principal, is willing to tolerate short-term price fluctuations, and has a mid- to long-range investment time horizon

40% Stocks, 60% Bonds
60% bonds / 40% stocksAverage annual return: 8.8%
Best year (1982): 26.4%
Worst year (1974): -11.5%
Years with a loss: 6

50% Stocks, 50% Bonds

50% bonds / 50% stocksAverage annual return: 9.1%
Best year (1995): 27.7%
Worst year (1974): -14.4%
Years with a loss: 7

60% Stocks, 40% Bonds

40% bonds / 60% stocksAverage annual return: 9.5%
Best year (1995): 29.4%
Worst year (1974): -17.2%
Years with a loss: 11

Growth - A growth-oriented investor seeks to maximize the long-term potential for growth of principal, is willing to tolerate potential large short-term price fluctuations, and has a long-term investment time horizon. Generating current income is not a primary goal.

70% Stocks, 30% Bonds
30% bonds / 70% stocksAverage annual return: 9.8%
Best year (1995): 31.1%
Worst year (1974): -20.0%
Years with a loss: 12

80% Stocks, 20% Bonds

20% bonds / 80% stocksAverage annual return: 10.0%
Best year (1975): 33.4%
Worst year (1974): -22.8%
Years with a loss: 12

100% Stocks, 0% Bonds

100% stocksAverage annual return: 10.5%
Best year (1975): 38.5%
Worst year (1974): -28.4%
Years with a loss: 12

It is important to note how the best and worst year performance percentages increase in absolute value with very little increase in returns. In other words the additional risks become greater and greater as we increase the equity portion whereas the returns increase marginally. It is suffice to say that taking extreme risks does not necessarily guarantee much superior expected average returns in the long run.

The next part of this series will showcase the models from American Funds. We shall discuss their informative charts which are pretty elaborate.

As always, we would love to hear about your experiences regarding asset allocation - specifically about the tools you used, or your model of choice or any other information that the rest of us would benefit from. Please feel free to share with us.

[Continued to Investing - Asset Allocation - Part 5]

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