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Hey Fools,

First-time poster here! I am a 30-yr old, fairly new-to-the game-but-willing-to-take-risks-because-I'm-young investor. I have a question about a 401(k) allocation suggestion that I found on this site.

I have about $25k in my 401(k) fund right now, and I'm looking to stray away from the age-based "2040" target portfolios through SEI investments and Fidelity, mostly because I'm picking up some pretty bad vibes around here about them (due to higher expense loads, not aggressive enough, etc.). That, and I've been pretty disappointed with their returns in the last 1.5 years, given the market's rebound.

In a very good Retirement article on The Fool's website, I saw the following chart on some advised allocation percentages for an "aggressive" retirement fund:

Large-cap US stocks: 40%
Small-cap US stocks: 20%
Foreign stocks: 20%
REITs: 5%
Bonds: 15%

I actually have two questions about this:

1) Where does a mid-cap index fund fit into this picture? Does their risk/return lean more to the large- or small-cap side? How can I fit a mid-cap into this allocation structure? I have Perkins Mid-Cap Value (JMCVX) available to me, and I like the looks of it - I just don't know where it fits here.

2) There are a few foreign stocks to pick from, some more risky than others. Emerging Markets being the riskiest. What do you think this specific asset allocation had in mind for "Foreign stocks" - something risky or conservative?


I've also been using mainly alphas and expense ratios when considering funds - I'm willing to pay for a higher alpha, but if all things look equal, I'm taking the fund with the lower expense ratio. This is why the Perkins Mid-Cap looked so attractive. High alphas at a reasonable expense.

Any feedback on my two questions would be greatly appreciated!



Let's make some money,
Carl
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At 30, you don't need any allocation to bonds. Stay 100% in equities.

No midcap because there have been studies that showed that midcaps were kind of a bastard child, and they don't help. Google it.

Foreign: You probably don't have many choices in your 401k. Go for something like EFA.
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Carl if you want to understand Asset Allocation I refer you to http://www.amazon.com/All-About-Asset-Allocation-Second/dp/0...

One of the things you will learn here is Mid caps offer virtually no advantage over a bit of Small Cap plus Large Cap.

Bonds in my view have no place in a 30 year old's portfolio unless you want to both limit volatility (up and down like has happened since early 2008) and lower your over all return between now and say 2040. Some people just cannot take the decrease in value that happened in 2008. They pulled funds out and shoot themselves in the foot. Those people literally bought high and sold low. Not a good plan.

Gordon
Atlanta
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If you're determined to add a mid-cap, I'd dump the large & small cap and just go with a total market fund. That way you get all 3 sizes in one.

Outside of that, I'd personally put more into REITs and foreign and less in USA and Bonds. Say 35, 35, 20, 10.

JLC
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Hey guys, I appreciate the replies.

Thanks for the advice on removing bonds - I was already thinking of changing that.

As for midcaps, you all seem to be implying that a mid-cap fund is generally a bad idea (or can be easily replaced by a large-small combo), but that doesn't align with research I've done saying that mid-caps are at all time highs and have fared better than both small- and large- caps in the last decade.

Dan Caplinger (TMFGalagan) actually mentions this in his latest article today:

http://www.fool.com/retirement/general/2011/02/03/how-invest...

"Brokamp's asset allocation doesn't stop there: He suggests putting 10% toward mid-cap stocks and 10% in small-caps...."

"What's behind the win?
The key to understanding why asset allocation has worked so well is in the performance of the various investments underlying it. Mid-cap stocks in particular are at new highs...."

I was thinking of just replacing the 15% to bonds with a midcap fund, actually. Does this suddenly make my portfolio a little too aggressive?

I am certainly willing to deal with the ups and downs - I won't touch this money for 30 years. But I don't want to go over the top.

Let me know if you have any additional thoughts.


Thanks,
Carl


P.S. TwoCybers - I actually started reading that book on Amazon.com (it has a free preview) and it was interesting so far. It had a good chart on return vs risk expectations over a 30 year period.
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As for midcaps, you all seem to be implying that a mid-cap fund is generally a bad idea (or can be easily replaced by a large-small combo)

Yes we are!

Not so much a bad idea or good idea - but lets use the morningstar X-ray tool and put in the Mid Cap fund JMCVX and find out just how much Mid Cap there really is in there.


Value Core Growth
11 22 12 LARGE = 45%
17 17 10 MID = 44%
5 5 3 SMALL = 13%


Seems to already be a good chunk of Large Cap -eh? So If you do a Large Cap and a Mid Cap??? You would be way over the top on the large - and very little small (almost the same as the Total Market).

Proforma - what if you put you hard earned dough in a Small Cap JSCVX and Large Cap JPLTX. (50/50) You would have:

Value Core Growth
15 22 9 LARGE = 46%
8 8 7 MID = 23%
10 11 10 SMALL = 31%


That would give you a good chunk of the Mid. IF you wanted to split the difference on the Small and Mid, do 58% Small & 42% Large and have
LARGE = 38%
MID = 24%
SMALL = 25%

Or if as mentioned you went with VTI (Total Market) you would have approximately -
LARGE = 70%
MID = 20%
SMALL = 10%
then just add small til you get whereever you want to go!

So Mid is easily replicated with other positions:


Risk return - Well the return piece (based on historical data - blah blah) fits more towards the Small Caps over long periods of time. But there is a lot of talk about Large being the place to be right now (see below) - so pull out the crystal ball.

We can definitely also compare some recent history to see how the three have tracked. Looking at 2004 to present, I would eyeball only about a 5% difference in Mid and Small Cap. And since the "not so great depression" Large caps have about 40% to go to catch up to Small and Mid. hence the "place to be" in some pundits eyes.....

JKD - Large Cap
JKG - Mid Cap
JKJ - Small Cap

http://finance.yahoo.com/echarts?s=JKG+Interactive#chart2:sy...

So lets say 35% (lets use JLC's numbers) to that part of the portfolio:

And 35% Foreign: That you might consider both developed markets (UK, Germany, Egypt :) and emerging markets (BRIC's - love that goldman term so financial sounding) you sound like you would probably lean toward emerging - --

20% REITS - well that is about where I am at so I like, maybe alittle less 18% or so but now we come to the final section BONDS!! A funny thing about investing in bonds - you know almost surely what you are going to get UPFRONT! Take advantage of that. To me (not a recipe for everyone) bonds are not very attractive until the mid term investment grade gets back up over 6%. And it may never happen again :) Because, upfront you are locking in a rate of return that I am willing to RISK someplace else and right now that other place is high yield and commodities. (high yield on hold because of my expectations on interest rates)

So - 20% commodities: Generically across several items with a focus specifically industrial metals - good diversification from the equities so you should get a reduction in portfolio volatility - if you can short coffee and go long lean hogs in your 401(k) let me know... otherwise maybe an ETF on industrial metals - if you are a beleiver you could go the precious metals route. I do think Pd has better upside as the Au/Ag you feel kinda bubbly to me!!!
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Great analysis by DrTarr!

BTW, if you really want some fixed income I suggest preferred stocks.

See this: http://www.preferredstockinvesting.com/newsletters/2011_feb....

I happen to know some of the symbols it talks about in the "short list".
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Carl your question was about Asset Allocation - But if you want a book about retirement which includes some on Asset Allocation see:

http://www.amazon.com/Conserving-Client-Portfolios-During-Re...

Yes it is an expensive book. In my view the best investment I ever made. A word of warning, it is like a lot of technical or text books -- poorly written. But in this subject, content is more important than style.

Gordon
Atlanta
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Dr Tarr:

Really interesting analysis. Like the OP, I have (what I thought was) mid-cap exposure in a combination of Ishares midcap 400 (IJH) and Fidelity's Low Price Fund (which I've had for approximately forever). Are they both not "really" midcaps per your analysis?

While we're at it, I'm two years from retirement and the stock portion of my portolio (60% of total portfolio) is:

large cap, 35%, a combination of stocks, s&P 500 index fund, and IVV

"mid-cap", 10%, IJH and Low-Price, as per above,

Small Cap, 5%, IJR (Ishares small-cap 600)

Emerging Markets, 10%, VWO (Vanguard)


Good, bad, or indifferent?

Thanks,

Case
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Case-

At two years from retirement what matters now is SIZE! Size of the portfolio compared to the size of withdrawal you will need.

For the exposure based on cap -IJH and IJR are Index ETF's and typically style/sector index funds are more true to their nature. Depending on the specific index there is usually only small variance in the index ETF's

Again - using Morningstars X-ray tool

IVV and SPY and the like usually come out about the same

Value Core Growth
30 30 30 Large 90%
5 4 3 Mid 10%
0 0 0 Small 0%

Because they are focused on the top 500 a very well defined group


IJR is focues in the small caps - not as clearly defined - down to $10MM or down to $5

Value Core Growth
0 0 0 Large 0%
1 2 3 Mid 6%
27 33 34 Small 94%

IJH is focused in the mid caps but spills into the smalls alittle

Value Core Growth
0 0 0 Large 0%
19 27 31 Mid 77%
9 8 6 Small 23%


But when you get into the funds - assuming the Low Price is FLPSX you can see the lines between small and mid are blurred.

Value Core Growth
6 7 4 Large 17%
18 16 11 Mid 45%
20 13 5 Small 38%

And another item of note for the Fidelity is that 35% of the holdings are foreign. The indices -based on US exchanges are primarily US stocks. So you get some global exposure there with the fund - Along with the IVV and the like you also have large multinational so while the percent is listed as US - again some exposure to the globe.

So- putting those together Morninstar says you are really

large cap, 39.6% vs 35%

mid-cap, 13.8% vs 10%

small cap, 7.2% vs 5%

foreign, 17% (with about 10% in Asia/Australia - leaving ~7% in perhaps emerging markets vs 10%

So - your portfolio seems to be pretty much on target for where you wanted to be!

Good, Bad, or Indifferent -
Those are your expectations to have.

I have some personal bias toward small caps - just seems like more room to grow and some research puts that group with a slightly higher return over the long haul. But I also note that large have not quite had the return coming out of the recent events. Is that because they were overvalued compared to the mid and small before or are they undervalued now? Current S&P 500 Price to Earning is around 24. Historical Mean is around 16 and change. IS that because earnings are still a little low coming out of the not so great depression. This gets broken down for me into sector price to earnings - right, utilities are not going to have the same P/E type ratios as Technology - -Financials etc. I think some are clearly over priced some are under priced. But for your portfolio - I think it is great that you are as close to where you wanted to be as you are. Many times - folks are not or they are challenged in other diversification issues. So - I might ask you if you have thought of commodities/metals or is that part of the 40% you don't list? And - you have some individual stocks as well. IF you are doing pretty good with those and have the time to play this game, consider doing some more. IF not - stick with the index ETF's and enjoy retirement.


d(P/E)/dT
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To be clear: The 50% you have in "Cap" based is really divided out such that

Large 30.0%
Mid 12.5%
Small 7.5%

(approximately)

When you add in the VWO that is where the additional amount in caps comes in (increasing Large to 39% etc.) - just like when you add the foerign from the fund to the VWO - that is where you get to 17% Didn't want you to think I had created extra money for ya - would if I could. but.
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I'm fortunate to say that I'm not concerned about size, and think I will be in good shape to support a 3% withdrawal rate (probably relying mostly on unavoidable dividends and interest for the "withdrawal"). I have no intention to trying to "beat" the market, and just want an asset allocation that largely protects the capital and provides some growth to protect against inflation. As I hit retirement itself, move the overall allocation from 60/40 to 50/50.

The stock portion of the large cap is about 5% and is largely just 10 major dividend payers of the Dow: for example, Exxon, JNJ, Kraft, Verizon,HP, a few others, plus a little Berksire, Google, and Microsoft. I realize that's largely redundant to the cap-weighted S&P Fund and increases the exposure in the largest cap area, but I like the psychic pleasure of owning some stocks directly.

The non-stock portion is:

25% BND (Barclay's indexed ETF)
7% SHY (1-3 year Treasuries)
5% TIP (TIPS ETF)
3% VNG (reit ETF)

I know I probably "should" have something in commodities, but I've never been comfortable with them.

Thanks again for all the help and advice.

Case
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I know I probably "should" have something in commodities, but I've never been comfortable with them.

If your satisfied w/o'em [income/estate needs will be met with reasonable assumptions] - no sense in it. Portfolio's are meant to help you sleep! Not make you uncomfortable!

As I hit retirement itself, move the overall allocation from 60/40 to 50/50.

Or just wait for another good market downturn to do that for you! Not to challenge your re-allocation but maybe some food for thought - Why are you making the change?

If 60/40 got you where you want to be, studies show optimal portfolio survivability/longevity is probably a little higher in equities, and you are comfortable where you are.. Plus, lets say rates are still low in two years (no crystal ball here)??? Do what makes the case for Case to sleep but don't just change allocation based on some idea that older means more Fixed Income, or that hitting the retirement date means reducing the amount of work your money can do.
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Yeah, I gotta disagree with the apparent consensus that mid-caps are bad investments. I love mid-caps and my equity allocation includes all three components. My mid-caps not only hold their own, but some of my best companies fall within the mid-cap range. Some of my worst companies fall into the small and large cap category. As with any investment, just picking a fund that is a mid-cap index is not sufficient. Do the research and find the fund or ETF whose prospectus best represents your investment goals.

Fuskie
Who has had great success with mid-cap companies...
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Dont think that is the consensus - and certainly did not mean to imply mid-caps were a bad investment - my point was that mid caps can easily be picked up in large and small or total market fund combo - sometimes unknowingly skewing an intended allocation. Agree- just picking a fund (in any capitalization) is not sufficient: Once you have your choice make sure it fits your strategy in reality not just because of its title.

d(mid-cap)/dT
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@DrTarr - Thanks for your excellent "actual-cap" analysis. Very helpful and it made me check out my whole 401k mutual fund portfolio in Morningstar's x-ray tool. Turns out my potential portfolio (including the mid-cap JMCVX) is at:

Cap --- Value --- Blend --- Growth
Large --- 21% --- 21% --- 11%
Mid --- 11% --- 7% --- 12%
Small --- 4% --- 5% --- 8%

i.e. - 53% Large, 30% Mid, 17% small.

Note that this is just my stock diversification, and doesn't include my 15% in bonds.

I don't mind my mix, although I may find a way to get more Smallcap in there. I'll probably take away some from my 15% in bonds, as some of you have advised.

What I've taken from all this good conversation - don't just buy into a mutual fund because of its name. Read the prospectus, take a look at what the fund is actually buying using Morningstar, and make decisions based on that.

Thanks everybody.


Carl
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Yeah, I gotta disagree with the apparent consensus that mid-caps are bad investments.

Who said they were bad investments? Not me!

What was said is that they don't add anything, if you already have largecaps & smallcaps.

my best companies fall within the mid-cap range. Some of my worst companies fall into the small and large cap category
But the question was *funds* and *ETFs*, not individual companies.
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