Index Mutual Funds, Current Asset Allocation, and Investment Strategy

Note: This post will serve as a running list of topics and updates related to mutual funds, asset allocation, dollar value vs. dollar cost averaging, and retirement investing accounts. The advice here should not serve to replace the advice of a financial professional, but rather is to give you some ideas to talk about further with your financial counsel.

Asset Allocation –

As a result of reading the books listed in the Financial Book Review post of my blog, I came up with the following target asset allocation percentages, based on my long-range view of investing and being young/able to tolerate high levels of risk.

% Equity = 75%
% Cash/fixed income securities = 25%
Total Portfolio = 100%

For the equity portion of my portfolio, my target split is shown below:

% US Domestic Equity = 71% (71% x 0.75 equity = 53% of total portfolio)
% International Equity = 29% (29% x 0.75 equity = 22% of total portfolio)
Total Equity Portion of Portfolio = 100%

To further break this down in to subcategories so we can select INDEX mutual funds to give us exposure to these areas, the books recommended the following %’s.

Detailed Allocation Calculations
1. % Cash (money market target 5%)
2. % Non-Inflation Protected Short Term and Intermediate Bond Funds (avoid long term bond funds) (target 15%)
3. % TIPS Bonds (Inflation protected bonds -target 5%)
4. % International Equity (Target 11%)
5. % International Emerging Markets (Target 11%)
6. % Domestic Large Cap (Target 8%)
7. % Domestic Small Cap (Target 8%)
8. % Domestic Small Cap Value (Target 14%)
9. % Domestic Large Cap Value (Target 13%)
10.% REIT (Real Estate Investment Trust – target 10%)
Total Net Worth = 100%

Recommended Vanguard Index Funds for These Categories – All of these have very low fees, and since they are index mutual funds, you will have higher returns than 70% of investing professionals with active management. You can open an account with Vanguard very easily at There are generally no commissions/fees for buying Vanguard funds through your Vanguard account. All funds require $1000-$3000 of initial principal to buy a particular fund.

1. Cash – place in high yield savings account – see blog post titled, Favorite Online Savings Accounts.
2. Vanguard Total Bond Market Index (MUTF:VBMFX) and Vanguard Short Term Bond Index (MUTF:VBISX)
3. Vanguard Inflation-Protected Secs (MUTF:VIPSX) – Note: this is an actively managed fund.
4. Vanguard Total Intl Stock Index (MUTF:VGTSX)
5. Vanguard Emerging Mkts Stock Idx (MUTF:VEIEX)
6. Vanguard Total Stock Mkt Idx (MUTF:VTSMX)
7. Vanguard Small Cap Index (MUTF:NAESX)
8. Vanguard Small Cap Value Index (MUTF:VISVX)
9. Vanguard Value Index (MUTF:VIVAX)
10.Vanguard REIT Index (MUTF:VGSIX)

Investing New Money when it Comes In –

So, I’ve bought the funds listed above, now what do I when I get my paycheck each month and have new money to invest? There are essentially two ways to do this exercise.  This is where dollar-value averaging and/or rebalancing comes in to play!

Portfolio Rebalancing

Portfolio is the process of maintaining the recommended allocation target %’s listed previous in order to maximize return and minimize risk. The rule I follow for when to rebalance is called the 5% rule. For example, the target allocation % for the REIT part of your portfolio is 10%. Following the 5% rule, you would rebalance the portfolio either by selling shares or contributing more money depending on whether the current % of the total portfolio was 15% or 5%, respectively.

As a general rule, I try to avoid selling shares of mutual funds (even in tax-sheltered accounts) frequently in order to perform rebalancing. Instead, when new money comes in, I buy additional shares in other funds if as needed to maintain my targets.

However, a full rebalancing of your portfolio should be 1X to 2X per year, unless your allocations targets are already aligned from keeping it up throughout the year with monthly investments.

Dollar Value Averaging

Another method of maintaining your portfolio/deciding how much money to invest and when is called dollar value average. This is similar to it’s cousin, Dollar Cost Averaging, but I believe it is slightly more effective.

In Dollar Cost Averaging, the idea is that a constant amount of money is invested each month in to your account, and therefore, will buy MORE shares when the market is down and LESS shares when the market is up.

However, in Dollar Value Averaging, the idea is to meet portfolio value goals that you pre-define at regular intervals throughout the year. For example, say you just bought the S&P 500 index mutual fund with Vanguard in your Roth IRA for $3000 in 2009. In 2010, you plan to contribute $200 per month to the fund for all 12 months. Therefore, you would then lay out value targets throughout the year as follows.

End of Month
Jan     $3200
Feb    $3400
Mar   $3600
Apr   $3800
May  $4000

At the end of the month, you assess the current value of the portfolio and compare it to the targets above. For example, if at the end of Jan, the fund is worth $2900, you would then contribute $300 instead of $200 in order to force yourself to buy more shares when the market goes down. Continuing with this example, so we invested $300 at the end of January. Then, at the end of Feb, the market has gone up a lot and we find that the value of fund is currently $3500. Since it is over our target, we would then invest nothing in the stock fund, and instead place the investment money in a cash or fixed income security. Make sense?

In my opinion, I believe that Dollar Value Averaging works best with a one mutual fund portfolio. Since I own a lot of mutual funds, I tend to steer clear of using it because it would be hard to apply to my situation.
Keep learning!



  1. I just pump money into the markets every 2 weeks to max out the $16,500 a year. I have a lot of company stock which I'm always getting each year I work too. I sell all I can every year b/c I don't want so much concentrated risk.
    My recent post Why Rental Property Is A Powerful Asset Class

    • Thanks for reading Sam! Thanks a good idea to sell some of your company stock so can get properly diversified.

      Do you find that contributing to your 401k every 2 weeks or every month works better?
      My recent post Tour de Personal Finance, Stage 3, Posts 27-30

  2. arborinvestmentplanner says:

    Jacob – you have laid out a well-diversified and low expense portfolio. Kudos. But where do you take into account valuations? Would you have the same asset allocation in 2000 as in March of 2009? That would not make much sense to me. I use a tactical asset allocation. It is more work but well worth the increased returns and lower volaitiliy. Here is an explanation for anyone interested:
    My recent post AAAMP Finished Week at All-Time High

    • Thanks for commenting Ken. The only changes in target asset allocations I make are in response to changes in life stages. For example, right now since I am fairly young (26), I'm pretty heavily investing in equity since I can afford to take more risk. However, as I get older and have kids, I will be changing that target to be heavier weighted in fixed income.

      So, to answer your question, the strategy does not take valuations in to account. From what I've read and studies I've performed, attempting to predict valuations and time markets only results in decreased performance.

      However, I would be open to hearing about a new strategy that I do not know of to see if it works and would be very interested in learning more about your strategy of tactical asset allocation. The post you inserted above doesn't go the specific details. Do you have another one that you've written?

      Also – you might be curious to talk to Rob Bennett, who is a big believer in Valuation Informed Indexing. You ever talked with him?
      My recent post Yakezie Blog Swap # 12 – Best and Worst Jobs in the World Edition Roundup and My Favorite Pick

      • arborinvestmentplanner says:

        I am very familiar with the work of Rob Bennett and have been privileged to have him write a couple of guest posts on the AAAMP Blog. My beliefs are close to his because I think valuation is VERY important. We do have some disagreements and I don't take the extreme percentage positions Rob does; in other words I never go 100% out of stocks but usually stay between 25% and 65% net long in stocks. There are always individual opportunities. I also have big problems putting so much faith in PE10 which has serious flaws (in my opinion).
        History has proven that with valuations such as we had in 2000 produce long term returns that are extremely small but with valuations such as we experienced in 1982 or 2008, the long term returns are far above average.
        Indexing without attention to valuation only guarantees an average performance. Sometimes the averages go long periods(often decades) of time with negative or near zero returns.
        Thanks for letting me share my thoughts.

        My recent post How Does the Inflation Trend Affect Your Asset Allocation?

        • Thanks for adding that information Ken!

          If you don't use PE10, what valuations indicators do you use?
          My recent post Yakezie Blog Swap # 12 – Best and Worst Jobs in the World Edition Roundup and My Favorite Pick

  3. arborinvestmentplanner says:

    PE10 is useful if you understand that 1 year (i.e. 2008) can totally distort it's result. It should be used with P/E , P/BV, Dividend Yield, investor sentiment, etc. But my absolute favorite valuation measure is Net Cash Flow. If I can find quality stocks with high net cash flow / enterprise value yields then I know the market has value. When net cash flow/ enterprise yields of stocks are low then the market is overvalued and I'm willing to hide in cash until I can get a return worth the risk I'm taking. Here is further reading on this subject:
    My recent post How Does the Inflation Trend Affect Your Asset Allocation?

    • Very interesting Ken. I've added this strategy to my list of things to dissect in greater detail.

      The thing that I do like about using Rob's PE10 method is that it is very systematic and based in set rules (ie you have X % equity when PE10 is at Y level) and also that PE10 is across the entire market.

      Are there net cash flow and enterprise yields published as one number summarizing all stocks? I worry that if you're left to interpret these signs for individual stocks, I'd have a greater liklihood of making mistakes.
      My recent post Easy Like Sunday Morning Weekly Roundup – # 2 – October 16th, 2011

  4. Kudos to you for starting so early with prudent, disciplined investing. And you can't go wrong with Vanguard. But I think you have way too many funds. For equities, you really only need two: Vanguard Total US Stock Market and Vanguard Total Int'l Stock Market. If you can tolerate more risk, consider adding their Emerging Market Index. The other thing is to convert these to Admiral shares as soon as you have a sufficient balance. Good luck!

    • Thanks for reading and good comment! It's been a while since I read about and decided upon the number of funds to carry in my portfolio, so I may be a little rusty. But, here's what I remember the books saying:

      First, I have read that you can obtain most of the benefits of diversification with only the two-three mutual funds you mentioned above. This is especially true for people just starting to create a portfolio and adding funds one by one.

      However, if you're sort of a “financial nerd” like me and enjoy getting in to the specifics, I read that you can obtain a small amount of additional diversification from adding small cap, small cap value, REIT funds, etc, since these have different correlation coefficients from the 3 main mutual funds you mentioned. Small cap value and value funds also expose you to a little more risk and give some more potential for higher returns.

      My recent post What Do You Refuse to Go Cheap On?

      • I see where you are coming from. For me in the past couple of years, it has been all about simplifying as much as I can. So I'm now exclusively focusing on those three funds I mentioned. Full disclosure: A few years back I did take positions in the Vanguard REIT index, the Vanguard Small-cap index, and the Vanguard Energy Fund. While I'm not purchasing additional shares (except through dividend reinvest), I am hanging on to them–gradually moving the shares into my Roth IRA each year. Another thing is that I'm a federal employee, so I'll have an ok pension, and I max out TSP every year. So hopefully this very simple index approach works-I still fudge the allocation percentages from time to time.

        Your dollar value averaging strategy intrigues me–this is something I want to learn more about. DCA is what I do now, but it's always grated on me for reasons I can't quite put my finger on.

        • Thanks for commenting Stoutboy! Those three funds sound like good ones to focus on. If you're interested in learning more about DVA, I wrote a couple articles about it a while back –

          Basically, what I've decided is that while DVA can potentially make you more money on paper/mathematically, it's much harder to implement because you have to buy large amounts of shares all at once, when you possibly do not have that much money in your cash accounts.
          My recent post Saving Money on Your Health Insurance

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