The Rule of 72 and Swensen’s Model of Asset Allocation
As we discussed here, the key to constructing a portfolio is not picking killer stocks! It’s figuring out a balanced asset allocation that will let you ride out storms and slowly grow, over time, to gargantuan proportions. To illustrate how to allocate and diversify your portfolio, we’re going to use David Swensen’s recommendation as a model. Swensen is pretty much the Beyoncé of money management. He runs Yale’s fabled endowment, and for more than thirty years he has generated an astonishing 13.5 percent annualized return, whereas most managers can’t even beat 8 percent. That means he has almost doubled Yale’s money every five years from 1985 to today. Best of all, Swensen is a genuinely good guy. He could be making hundreds of millions each year running his own fund on Wall Street, but he chooses to stay at Yale because he loves academia. “When I see colleagues of mine leave universities to do essentially the same thing they were doing but to get paid more, I am disappointed because there is a sense of mission,” he says. I love this guy.
Anyway, Swensen suggests allocating your money in the following way:
30 percent—Domestic equities: US stock funds, including small-, mid-, and large-cap stocks
15 percent—Developed-world international equities: funds from developed foreign countries, including the United Kingdom, Germany, and France
5 percent—Emerging-market equities: funds from developing foreign countries, such as China, India, and Brazil. These are riskier than developed-world equities, so don’t go off buying these to fill 95 percent of your portfolio.
20 percent—Real estate investment trusts: also known as REITs. REITs invest in mortgages and residential and commercial real estate, both domestically and internationally.
15 percent—Government bonds: fixed-interest US securities, which provide predictable income and balance risk in your portfolio. As an asset class, bonds generally return less than stocks.
15 percent—Treasury inflation-protected securities: also known as TIPS, these treasury notes protect against inflation. Eventually you’ll want to own these, but they’d be the last ones I’d get after investing in all the better-returning options first.