Asset Allocation Step 3: Implement Your Plan

Thursday, April 15, 2010   

Now that you’ve decided on a risk-appropriate equity/bond split and broken down the equity and bond portions of your portfolio into target percentages, you’re technically finished with the asset allocation process.  Of course, there’s still the small matter of implementing your plan.  With thousands of investments to choose from, how should you go about narrowing down the field?  I’m glad you asked.

What You Can’t Control: Your 401(k) Choices

As I talked about in a previous post, not everyone is blessed with a flexible, option-laden workplace savings program.  Lobbying for better fund choices can eventually produce results, but in the meantime, you’ll have to choose from the funds available.  When in doubt, pick the lowest cost funds that still fill a position in your asset allocation plan.  If you aren’t sure about a particular fund’s asset class, plug the ticker symbol into Morningstar’s Instant X-Ray Tool to find its exposure to size and value factors.  You may discover that you need to simplify your asset allocation plan due to a lack of fund choices, but that’s not necessarily a bad thing.  Generally speaking, no matter how poor your 401(k) choices are, it’s well worth it to contribute up to the full employer match.

What You Can Control: Investing Costs

Fees, expenses and taxes can all take large pieces of your investment returns, but fortunately, there are some steps that you can take to minimize these investing costs.  First, reduce expenses by investing in low-cost index funds and ETFs.  Two out of three actively-managed mutual funds fail to beat their benchmark each year because of the burdensome costs of active management; don’t let those costs be passed on to you!  Next, pay close attention to all applicable fees and commissions prior to doing business with a particular brokerage firm or mutual fund company.  IRAs and other investment accounts are extremely portable, so there’s no good reason to stick with a high-commission broker.  Vanguard account holders receive commission-free trades on dozens of low-cost index funds, and several brokerage firms are now offering Commission-Free ETF Trades.  Finally, maximize your portfolio’s after-tax returns by placing tax-inefficient asset classes (e.g., REITs, Bonds) in tax-deferred accounts.   

Staying on Track

Choosing an asset allocation is the single most important decision that you’ll face as an investor, but, as I’ve said before, successful investors don’t just develop a good plan; they stick with it.  My favorite tool for maintaining investing discipline is the Investment Policy Statement (IPS).  This document provides an organized framework for recording your investing goals, philosophy and target asset allocation so that you can help yourself resist the temptation to stray from your long-term strategy.  I highly recommend that you draft an IPS while the rationale for your asset allocation decision is fresh in your mind.  If you need help getting started, download our Sample IPS.  Armed with a well-documented, risk-appropriate asset allocation plan, you’re one step closer to realizing your investing goals. 

Reminder: The asset allocation process that I’ve described in the last several posts may sound like a lot of work, but you don’t have to tackle it on your own.  The free portfolio recommendations on include a breakdown of your risk profile, historical risk/return statistics, specific mutual funds and ETFs in which to invest, and additional tools and tips for maintaining your portfolio.

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