Developing an Asset Allocation Model (Part V)

So far we’ve discussed the need to understand your risk tolerance before developing an asset allocation strategy, the four main asset classes we’ll consider and two posts on various asset subclasses.This post puts it all together in a personal Asset Allocation Policy. This post and the final post will present my rationale for the allocation I’ve chosen.

Before we do that, however, we need to deal with two assets: Personal Real Estate and Social Security.

Personal Real Estate

My philosophy has always been that my house is my home. If I happen to make money on its appreciation, great, but my main reason for buying a house is to live in it. I am fortunate enough to have two houses, one north and one south. When I become sufficiently decrepit, I will sell the northern house and live full-time in the south. More decrepit and I’ll end up selling the southern house and living in an assisted care facility or nursing home (ugh).

I have not bought and do not plan to buy long-term care insurance. I treat my housing as that insurance. When it comes to my personal balance sheet, I show my two homes as “Other Assets.” When it comes to my Asset Allocation Policy, I do not include them at all. That’s just my way of doing it; you may choose otherwise.

Social Security

I noted earlier that I treat the defined benefit pension I receive from a former employer as a bond. By parallel reasoning, I should treat Social Security as an indexed bond because the monthly payments are linked to CPI. But I don’t.

I do not have post-retirement medical insurance from my employment. I am purchasing catastrophic coverage until I reach Medicare eligibility, at which point I will have whatever Medicare coverage is then available. (It has to change, but that’s a topic for another post.) I’m sure I will need to purchase a supplementl policy to cover what Medicare does not.

I really have no clue where healthcare in the United States is going, and so for now I have olayed the entire issue by keeping the value of my future Social Security Payments off balance sheet. My implicit assumption is that the red cape of my Social Security payments will cover the charging bull of my post-65 medical costs. It’s inaccurate, mismatches timing somewhat, but it works for me—which is why you won’t see Social Security in my Asset Allocation Policy.

If you (very reasonably) take a different approach toward your Social Security Benefits, I recommend you treat it as an inflation-protected bond.

Jim’s Asset Allocation Policy

So here we are after four and a half posts at the moment to cue the drummer and press the red button that activates the stage curtain. It retracts and reveals:

Jim’s Asset Allocation Policy as of 24 December 2010:

Bonds: 44.0%
  Short-term Balancing Item
  Medium-term 0.0%
  Long-term 0.0%
  Inflation-protected 15.5%
  Pension Actual%

Equities 50.0%
  US Large-cap 23.0%
  US Small-cap 10.5%
  Europe 7.5%
  Pacific 3.5%
  Emerging Markets 5.5%

Other
  Real Estate 3.0%
  Commodities 3.0%

Total 100%

In the final post of this series, I’ll discuss the rationale for my current thinking and what changes might cause me to modify the policy in the future.

~ Jim