We know we should save and invest but how should we invest? We’ve seen from a previous article that we should dollar cost average to even out our entry price. But what should we invest in?
I’m a big believer in following (scratch that, copying) the best. Who are the best asset managers over the long term? I’m going to talk about two: David Swensen, CIO of Yale University Endowment and Ray Dalio, co-CIO and founder of Bridgewater Associates, and look at the asset allocations that they use.
What is an asset allocation?
An asset allocation is how your asset classes within your portfolio are divided. An asset class is a type of asset, so one asset class could be stocks (equities), it could be bonds (fixed income), it could be property, gold or just straight cash. It could even be cryptocurrency :).
So for many people, their major asset class is property ie their house, which dominates their portfolio. That might be an asset allocation of 98% property, 2% cash (in the bank).
What is the point of a good asset allocation?
All investors are looking for returns and they’re all looking for the biggest returns they can get. However, the biggest possible returns come from being concentrated in a few investments. Think Bitcoin in 2017. You could have made a lot of money and you could have lost a lot of money.
The point of a good asset allocation is to reduce the bumpiness, the downsides that come with concentration, whilst still producing decent returns.
Stocks over the past 100 years have produced around 8% per year. However, this comes with a good deal of bumpiness. Within those 100 years, you’ve had several bull markets and several bear markets. How do you even out the bear markets and the bull markets? You diversify into other asset classes like bonds and property. You might not get the 8% returns that you might get over the long term had you invested solely into stocks, but you will get a more even ride.
David Swensen’s asset allocation
David Swensen has a phenomenal long-track record, averaging 13.9% per year in the 20 years to 2015. To put that into context, most managers don’t make to 10 years let alone 20 years. And even fewer of those make it to those sort of returns. Swenson is pretty much a unicorn.
I first heard about him from Ramit Sethi’s excellent personal finance book, I Will Teach You To Be Rich (comedy title I know, but it’s real deal, legit advice and I reviewed the book in a previous article here). In the book, Sethi outlines Swensen’s asset allocation.
Ray Dalio’s All-Weather asset allocation
Ray Dalio also has a stellar long-term track record. He manages the biggest hedge fund in the world, valued at USD$120bn. He has a few strategies and one that is featured in Tony Robbins’ book Money is called the All-Weather strategy. It follows a so-called risk parity model and this is helpfully laid out in this article from Tony Robbins’ site. The objective of Dalio’s asset allocation is to produce a portfolio that does well in good times and bad times in the market.
Here’s a quote from the Robbins article:
First, Dalio says, we need 30% in stocks — for instance, the S&P 500 or other indexes, for further diversification in this basket.
Then, you need long-term government bonds. Dalio recommends 15% in immediate term (seven- to ten-year Treasuries) and 40% in long-term bonds (20- to 25-year Treasuries). This counters the volatility of the stocks.
Finally, Dalio rounded out the portfolio with 7.5% in gold and 7.5% in commodities. As he notes, “You need to have a piece of that portfolio that will do well with accelerated inflation, so you would want a percentage in gold and commodities. These have high volatility. Because there are environments where rapid inflation can hurt both stocks and bonds.”
Lastly, don’t forget to rebalance. Meaning, when one segment does well, you must sell a portion and reallocate back to the original allocation. This should be done at least annually, and – if done properly – it can actually increase the tax efficiency. For more information on rebalancing see our article on investment strategy.
Now you’re ready for whatever comes your way, be it the longest bull run in U.S. history… or a sudden crash.
Differences between the two asset allocations
You’ll see from both asset allocations that they are quite different in make up. Dalio’s is heavier on bonds, with government bonds making up 55% of his allocation. Swensen’s asset allocation has a total of 30% in government bonds. Dalio’s also has gold (7.5%) whilst Swenson’s does not. Dalio has no property whilst Swensen does (REITS 15%).
Similarities between the two asset allocations
They are both well-diversified, and particularly, they aren’t too heavily weighted towards stocks/equities. A lot of the time, you might want to go for maximum growth, so you might put your whole allocation towards stocks/equities, and whilst this might achieve strong growth over the long-term (20 years), you will have some bumpiness and losses in the bear markets that are inevitable. The bonds will help even this out, although perhaps at the expense of maximal returns. Following Swenson’s asset allocation though might net you a 13% average annual return, which is pretty damn awesome.
Why dollar cost average?
We’ve seen from my earlier article that dollar cost averaging is a way to achieve the likelihood of a good entry price. Say that you had £10,000 to invest in one stock, say Rolls Royce. You could put that all into Rolls Royce now at 981p, or you could invest £1,000 into Rolls Royce at the same time each month for a total of 10 months. Your average entry price might be £10.58 or it might be £8.70, but at you won’t be kicking yourself if you entry price was £8.70 and not £9.81 as it would be if you pumped it all in today.
Why automatically invest?
If you’re not a great saver (I’m NOT a good saver), then automatically investing is a great idea. It means that you don’t have to rely on manually investing, and you don’t have to rely on your discipline and willpower to do so either. You set up a sweep from your paycheck on pay day, that takes money from your current account so that you don’t even see it. You don’t miss it. This then is wept into your investment account.
Why use Hargreaves Lansdown as your investment platform?
I’ve been using Hargreaves Lansdown for several years now. It’s a very user-friendly platform and one of the biggest for normal, retail investors like you and me. It also has access to a huge range of funds from different fund managers and has the ability to allow automatic investing on a monthly basis. It will pull money from your bank account (an amount that you set) and at the same time each month (7th), it will invest according to your instructions.
Check out Hargreaves Lansdown here.
So how do we replicate the Swenson or Dalio asset allocation within Hargreaves Lansdown?
Now we get to it! The most important things when selecting which investments to make within Hargreaves Lansdown to achieve the above asset allocations are:
- reducing your tax. Tax will eat and destroy your long-term returns if you let it. This means only using a tax-sheltered investment vehicle. This means in the UK that you MUST invest through a Stocks and Shares ISA. There are annual limits on the amount of money that you can put into this to invest, but I personally don’t come near those. If this is an issue for you, then max out your Stocks and Shares ISA first, before investing through a normal investment platform.
- minimising fees. Active fund managers will charge up to 2% per year to manage your money. This might not sound a lot but it is! If you’re making 8% per year in returns but you have to give the manager 2%, then that’s 25% of your total returns! We’re going to look mostly at low-cost, low-fee, index funds.
- good ratings by the investment platform. Hargreaves Lansdown have a useful tool called the Wealth 150, which they say:
The Wealth 150+ is a selection of our favourite funds available to UK investors. We believe Wealth 150+ funds offer the ultimate combination of first-class long-term performance potential and low management charges. It is designed for people who would like to choose their own funds and doesn’t constitute a personal recommendation.
Why choose the Wealth 150+?
- A strong track record of selecting funds which deliver impressive overall long-term performance in each sector
- Our experienced research team analyses all the major markets and sectors to identify the best long-term prospects
- We spend thousands of hours each year scrutinising investment strategies, performance analysis, and fund managers
- Some of the lowest ongoing fund charges available anywhere
Below we also include our Wealth 150 funds which we believe have excellent long-term prospects, but don’t have quite the same combination of ‘best-in-class’ performance potential and low charges as Wealth 150+ funds. Additionally, we include our Wealth 150+ trackers – our favourite funds that track the performance of a stock market index. (Here’s the link to the above quote from Hargreaves Lansdown)
The last two things, minimising fees and good rating, are our main criteria when selecting the right index fund for each asset class.
Here is my initial spreadsheet with the relevant index funds against each asset class:
This spreadsheet shows how I split a monthly investment of £275 according to the David Swensen asset allocation, or at least as close as I can get to it. (I’ve recently upped this to £375 per month as I’ve finished paying my student loan off :))
Here are the relevant screens in Hargreaves Lansdown to set up your monthly investments:
What asset allocation do you use? Let me know in the comments below.
Also let me know any questions in the comments below!
