How to Pick a 50/50 Portfolio
50/50 portfolio. Have you decided to go conservative? That is, to De-Risk?
If so, you may have a 60/40 portfolio. Or 30/70. Or, 50/50 invested equally in stocks and fixed income.
I wanted to look at a popular 401k provider and see how to build a 50/50 portfolio.
Let’s dig in and see what mutual funds are available, how to choose which fund to invest in, and how to get to 50/50 asset allocation in my active 401k.
Why a 50/50 Portfolio?
Sequence of Return Risk is one major reason why you want a conservative asset allocation. If you are retiring soon, then go conservative!
Another reason is personal risk tolerance and appetite for risk. If you can’t take a 40% decline in the stock market and might sell low, it is better to mix in bonds with your stocks to decrease volatility.
Other folks have already won the game and don’t need any more risk.
Regardless of reason, let’s see what a 50/50 asset allocation looks like at a popular on-line 401k provider.
Asset Allocation for a 50/50 Portfolio
Above, you can see the asset allocation for my 50/50 portfolio at a popular on-line provider.
On the left in more detail, my asset allocation is approximately 50% bonds, 30% US equities, and 20% international equities. This mirrors a Boglehead 3 fund portfolio.
In the middle, the actual funds utilized are broken out into percent of the portfolio. I have about 50% invested in the only total bond fund option available in my plan. This is an active bond fund with a moderate expense ratio. For the remaining 50%, I have 20% in international, and 10% each in large, mid, and small cap investments. In regards to global equity, this is overweight US (as US equities are just over 50% of total). In regards to US equity, this is overweight (or tilted) towards smaller and mid-sized companies.
Note on the right that this was all deferred compensation as the employer does not offer contributions to this account. If you have employer (or post tax!) contributions, it would show up here.
How did I get to this asset allocation? Let’s look at the options available to invest in my 401k plan.
Stock Funds Available in my 401k Plan
You can see there are 10 funds to choose from for equity exposure.
As you know, 401k plans are protected by ERISA, so employers limit the investment options in order to promote their fiduciary responsibility to you. There are just bread-and-butter options available to employees; no crazy triple leveraged ETFs to choose from!
So, should I be looking at the 1, 3, 5, or 10 year returns when picking equities?
None of the above! Remember, past results don’t imply future returns!
You cannot control the returns of the market. The only thing you can control is the fees or expense ratios of what you invest in. Where are the expense ratios?
Above, you can see there are two Large Cap options. There is an inexpensive index fund, and then a rather more expensive value fund. For mid-caps, there is an inexpensive index fund and an active growth fund.
There is only one small cap option but 5 international options! I picked the inexpensive, broadly diversified international fund, but also the expensive small cap fund. I talk about why I included small caps below.
Fixed Income options in my 401k plan
Essentially there are only 5 options for fixed income. Above, there are two blended funds, two bond investments, and a money market fund.
As I’m going to have to pull out money in this account, I don’t want target date funds or blended funds for my fixed income option. If all I own is a target date fund or a blended fund, in order to get a distribution I have to sell the entire fun–stocks and bonds. I want the ability to sell either stocks or bonds. This allows me to keep my asset allocation at a level of my choosing depending on which funds I sell. Remember that de-accumulation is very different than accumulation!
Do pay attention to returns on bonds. As opposed to equities where you cannot know future expected returns, for fixed income current yields do predict future expected returns.
Fixed Income in a 50/50 Portfolio
Above are 5 fixed income options. The top two are target date funds for 2020 and for current retirees. These have equities in them, so you see their 5-year returns (in red and yellow) are quite a bit more volatile than the true bond funds. This is another reason why you don’t want to mix equities and bonds in a distribution portfolio.
My three fixed income options are: 1) an intermediate core-plus actively managed total bond fund, 2) an inflation protected bond fund with low yields, and 3) a money market fund.
If I needed all the funds next year, I might be in a money market fund. Returns (in green) aren’t sexy, but you see they “never” lose their value.
Inflation is not a huge concern of mine in the short term, so I chose the higher yielding bond fund for the next ~10 years of this plan’s life.
Investment Decisions in a 50/50 Portfolio
Asset allocation, after the decision to invest in the first place, is the most important decision you make in investing.
Since there are limitations on the investment options in a 401k plan, after deciding on asset allocation, look at what funds are available to you.
Are there any good fixed income funds? Do you want to put fixed income in your 401k or somewhere else? This is important: You DON’T need to have your entire asset allocation reflected in each separate account!
Let me say that again: Asset Allocation is your stock/bond ratio in all of your accounts.
If you don’t have good fixed income options, maybe you can put a total bond fund in your IRA as part of your overall asset allocation.
Next, what equity funds are available? Do you have any small cap or value options you can use to tilt your portfolio?
Future expected returns of equities are difficult to predict. Obviously. But using factors that in the past have been associated with increased risk, you might increase future returns.
The Callan Table and a 50/50 Portfolio
Don’t fight the last war.
In investing, at least, the past returns are frequently not indicative of future results.
In fact, using the Callan table, you can see there are trends which are short term. Due to reversion to the mean, asset classes that have done well in the recent past are more expensive and have lower future expectations that other asset classes.
Don’t fight the last war and pick last years’ winner. This is buying high.
In my case, there aren’t a lot of great options. My small cap is growth, the mid-caps are all growth. There are value funds for US and international, but alas I have decided the Expense Ratios are not worth holding these funds in this account. I have exposure elsewhere at a better price.
Summary 50/50 Portfolio at a Popular 401k Provider
My overall asset allocation is not 50/50, but my 401k is a 50/50 portfolio.
There are several reasons to go conservative. When you make the decisions, often times you are limited by what options you have in your 401k.
Here, I have actively managed bond funds, which I don’t mind paying a bit more for. In addition, I’ll pay a bit more for actively managed small cap funds as well. I’m trying to use a bit of equity risk parity and the Callan table (and luck) to go for higher returns over time.
Discover what your options are in your 401k. Do you have some good funds to worth with? If you have a large 401k and not much else, it is difficult to find a perfect 50/50 portfolio. Work with what you have and don’t let perfect be the enemy of good enough.