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May the source be with you, but remember the KISS principle ;-)
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Those strategies as a minimum use your age as the parameter that affects your investment allocation decisions. Proxies of age like number of years before retirement might actually be preferable.
The simplest variant is based on use of "prepackaged" lifecycle funds. Vanguard now propose a lot of such funds called Retirement 2005, 2010, 2015 and so on. Preset asset-allocation strategies, or lifestyle funds, are either static or age-adjusting. Approximately half of 401K plans offer at leat one such plan
Static funds divide investments between stocks and bonds funds with preset ratios (they are fund of funds). For example Vanguard has three funds:
Vanguard LifeStrategy Growth (VASGX ) 80% stocks. 20% in bonds mix
Vanguard LifeStrategy Conserv Growth (VSCGX) 40% stocks, 40% bonds, and 20% cash mix
Vanguard LifeStrategy Income (VASIX ). 60% bonds, 20% cash and 20% in stocks mix (this interesting fund actually is dynamic allocation fund as stock portion can vary depending on market conditions).
The idea here is that investor himself can rotate his
funds to more age-suitable allocation as he/she grow older. If all
three funds are present in your 401K portfolio then using simple
mathematic you can approximate any necessary ratio of bonds and stocks.
You also can minimize the number of moves by rounding the necessary (for
example your age based) ratio to 5% multiples. That makes the number of
moves even really minimal.
Age-adjusting funds are target-date portfolios where the allocation become more conservative as an employee nears his or her "target date" which is usually the year of retirement.
| Name | Price as of 10/12/2006 | YTD Returns as of 10/12/2006 |
Average Annual Total Returns as of 09/30/2006 |
||||||
|---|---|---|---|---|---|---|---|---|---|
| Price | Yield | 1 Year | 5 Year | 10 Year | Since Inception | ||||
| LifeStrategy Consrv Grwth | $16.26 | 3.12% | B | 7.13% | 7.79% | 6.72% | 7.59% | 8.73% | 09/30/1994 |
| LifeStrategy Growth Fund | $23.03 | 2.02% | B | 10.66% | 11.04% | 9.09% | 8.40% | 10.06% | 09/30/1994 |
| LifeStrategy Income Fund | $13.83 | 3.74% | B | 5.28% | 5.99% | 5.47% | 7.07% | 8.02% | 09/30/1994 |
| LifeStrategy Mod Growth | $19.84 | 2.63% | B | 8.76% | 9.32% | 8.04% | 8.15% | 9.52% | 09/30/1994 |
| Target Retirement Income | $10.55 | 4.11% | B | 3.82% | 4.36% | — | — | 5.55% | 10/27/2003 |
| Target Retirement 2005 | $11.47 | 3.44% | B | 4.94% | 5.13% | — | — | 6.59% | 10/27/2003 |
| Target Retirement 2010 | $21.22 | 2.96% | F | — | — | — | — | 5.05% | 06/07/2006 |
| Target Retirement 2015 | $12.26 | 2.71% | B | 6.98% | 7.25% | — | — | 8.43% | 10/27/2003 |
| Target Retirement 2020 | $21.44 | 2.42% | F | — | — | — | — | 5.70% | 06/07/2006 |
| Target Retirement 2025 | $12.72 | 2.23% | B | 8.07% | 8.18% | — | — | 9.51% | 10/27/2003 |
| Target Retirement 2030 | $21.64 | 1.99% | F | — | — | — | — | 6.25% | 06/07/2006 |
| Target Retirement 2035 | $13.44 | 1.95% | B | 9.62% | 9.70% | — | — | 11.31% | 10/27/2003 |
| Target Retirement 2040 | $21.54 | 1.93% | F | — | — | — | — | 5.65% | 06/07/2006 |
| Target Retirement 2045 | $13.87 | 1.96% | B | 10.34% | 10.70% | — | — | 12.41% | 10/27/2003 |
| Target Retirement 2050 | $21.65 | 1.98% | F | — | — | — | — | 6.20% | 06/07/2006 |
A popular rule of thumb is to subtract your age from 100. The difference represents the percentage of stocks you should keep in your portfolio. For example, if you are age 40, 60 percent (100 minus 40) of your portfolio should consist of stock. However, you may want to modify the result after considering other factors, such as your age, risk tolerance, and financial goals.
The American Institute of Certified Public Accountants
My simulations had shown that binary mix of
large indexes using 100-your_age mix of stocks and
your_age% bonds for the historical period
used (reader beware!) provides better average returns
then either 100% of stocks or 100% of bonds. There are exceptions -- for
those who retired in June 2000 with all stock portfolio would provide better
returns if they sold it immediately, but they are very few. For baby boomers
and the period that I used in simulation runs (ten year period with start
dates varied from 1990 to 1996) it has less risk and higher median returns
then all bond portfolio.
Although it looks like defensive strategy: maximum is less the in all stock
portfolio but minimum is substantially higher it actually provides better
returns in more then 80% simulation cases in my 1990-1996 runs. We
should admit that there its a little bit too simplistic and there is not
too much scientific evidence about viability of this strategy in various
market conditions other then the name "classic" and obvious simplicity.
Rephrasing Churchill it might be even bad strategy, but other mentioned
above might be even worse. In this case you can beat 100% stable value
fund investing strategy for the last ten years -- no small trick for any
401K investor :-). At least it is easy to understand why it is improves
returns and thus can fine-tune it.
Rebalance or not to rebalance
(or to be exact when rebalance) is another important question. I do not know
the answer. One thing that is important-- you should definitly avoid blind
yearly rebalancing (a la William Bersheim "Intelligent Investor" recommendations).
The right time for rebalancing are abnormal differences in returns on your
stock and bond parts of the portfolio. That means that it makes sense to
rebalance only if the difference with projection exceeds, say, 10% or
20%.
You can also try to use value-averaging based strategy approximating the amount you should have in stocks and bond at retirement and making compensating contributions when the difference exceed certain percentage points. In this case you need to create a spreadsheet with the simulated life investment growth based on assumption that the stock index portion should generally return 7% a year and bonds index around 5% a year. If they fail to do so you simply need to contribute more during the particular year but this way you will get the final amount no matter how the market will behave. Still you need to increase your cash portion of bond portfolio as bond fund doe not provide preservation of your principal if you do not keep them to maturity. If you are lucky and start with several good years you will have a sizable stable value reserves from over-performance of say, stock part of the portfolio, the reserves that you can use during bad years for compensating lower returns.
Recently Vanguard and other funds introduced "Life cycle funds" that are tuned to a particular retirement date and intended to be "one stop" investment for the whole 401K portfolio. That can use more complex dynamic allocation strategies then binary socks/bonds strategy but all of them increase the share of more conservative investments with time. As they are example of "buy and hold" strategies they also have considerable risk of recession-related losses.
There are more also more elaborate customizable strategies on web sites like 401Kafe.comCopyright © 1996-2008 by Dr. Nikolai Bezroukov. www.softpanorama.org was created as a service to the UN Sustainable Development Networking Programme (SDNP) in the author free time. Submit comments This document is an industrial compilation designed and created exclusively for educational use and is placed under the copyright of the Open Content License(OPL). Original materials copyright belong to respective owners. Quotes are made for educational purposes only in compliance with the fair use doctrine.
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Last modified: October 22, 2008