When Should You Change Your Asset Allocation?

A reader asks:

My question is how does asset allocation strategy change with your net worth? For example, should someone of the same age with $10 million in net worth have the same allocation as someone with $1 million?

The bulk of my career has been spent working in the institutional investment space — mainly foundations and endowments.

These huge pools of capital liked to call themselves “sophisticated” investors. And don’t get me wrong, some of them are very sophisticated.

But far too many of these funds that manage tens of millions or even billions of dollars in capital make things far more complicated than they need to be.

The assumption is since these funds have so much money and connections in the finance industry that it makes sense to invest in more complicated fund structures like hedge funds, private equity, venture capital, infrastructure, real estate and other hard assets.

A handful of these funds do have the ability to employ these more complex strategies but the majority of nonprofits would be better off keeping things simple. Not everyone can invest in the top quartile or decile of the best funds (by definition).

Complex problems like the financial markets don’t have to require complex solutions to reach your goals. There’s an old saying that people don’t go to church on Sunday to learn about the 11th commandment.

The same applies to investing — you don’t have to reinvent the wheel simply because more money is at stake.

It took me a while to come to this realization, but from a portfolio management perspective, managing more money just means a few more zeroes.

If anything, the bigger and more complex your finances, the simpler your investments should be. This is because the rest of your financial life is more complicated from a financial planning perspective (taxes, estate planning, insurance, etc.).

Regardless of how much money you have, the things that matter the most when creating an investment plan are:

Your risk profile. What is your willingness, need and ability to take risk?

Your time horizon. When are you going to spend the money?

Your current circumstances.  Where do you stand right now in terms of your finances?

Your goals. Where do you want to be in the future?

Those are always going to be the main building blocks of a successful investment plan whether you’re managing $10,000 or $10 million.

Your risk profile is a big one as you move up the net worth scale.

If you’re lucky enough to have a net worth with two commas or more, your ability to take risk is fairly high but your need to take risk is fairly low. You can take more risk but you don’t need to if you have a lot of money (and don’t spend too much of it).

So then it really comes down to your willingness to take risk.

What is your risk appetite? How big do you want to grow your nest egg? How comfortable are you with losses and volatility?

These questions aren’t always easy to answer because you have to balance out your desire to grow your wealth with your desire to avoid losing it.

Some people with a lot of money are comfortable keeping the bulk of their net worth in equities because they understand the risks and higher expected returns.

Other people with a lot of money are more comfortable keeping the bulk of their net worth in safer assets because they understand the risks and lower expected returns.

There are no right or wrong answers to these questions.

Risk is personal.

The real question here is: When does it make sense to change your asset allocation?

Some thoughts:

When the market changes the opportunity set in a meaningful way. These past few years have offered some challenging times for diversified investors.

Interest rates had been falling for years. Then the pandemic hit and rates went from low to the floor. With yields on safe bonds at 1% or so, many investors who would have been better suited for a 60/40 portfolio decided to go further out on the risk spectrum and utilize a 70/30 or 80/20 portfolio.

Now that bond yields are back at 4-5%, those very same investors are probably considering a 60/40 again or even a 50/50 portfolio.

Sometimes you can simply change your expectations instead of changing your portfolio. But there are times when the market can dictate how you are positioned, assuming you understand the trade-offs of taking more or less equity risk.

When you picked the wrong portfolio in the first place. Sometimes it takes a nasty bear market to realize your true tolerance for risk. There’s no shame in dialing down your risk when you realize the allocation you picked is not the right fit.

The hope is you learn this lesson at a young age and pay your tuition to the market gods early on in your investing career.

When your circumstances change. In Home Game: An Accidental Guide to Fatherhood, Michael Lewis notes he became more risk-averse after having children:

Small children are also a mood-altering substance with financial consequences. Their effect on the human mind is the opposite of Prozac. At any rate, my own current financial taste for cash and bonds seems to be at least partly a response to parenthood.

Some people change their portfolio when they get married or receive an inheritance or get a new job or some other life event. And sometimes your relationship with risk changes as you age and mature.

A 20% loss when your portfolio is $10,000 is a loss of $2,000. That same 20% loss at $1 million is $200,000. Some investors simply cannot handle experiencing such large dollar drawdowns.

The biggest thing here is you should always have a good reason for making an allocation change. And you shouldn’t make a habit of it.

There’s an old saying that your portfolio is like a bar of soap. The more you handle it, the smaller it gets.

We talked about this question on the latest edition of Portfolio Rescue:

Blair duQuesnay joined me again this week to discuss questions about real interest rates, making up for lost time with your retirement savings, series I savings bonds and Monte Carlo simulations for financial planning.

Here’s the podcast version of the show:

Further Reading:
6 Reasons For David Swensen’s Success at Yale

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