Portfolio Design: A Modern Approach to Asset Allocation

PORTFOLIOS OF STOCKS AND BONDS

By the time of retirement, the investor should have reduced the proportion of stocks in the portfolio way below that chosen during earlier working years. As discussed above, the Vanguard Target Retirement Fund shifts the investor from a 90 percent stock portfolio when the investor is 25 years from retirement to a 50/50 portfolio at retirement. The 50/50 retirement portfolio is a common one chosen, at least early in retirement.

Because risk is central to the success or failure of spending rules, we will try to reduce risk by diversifying the portfolio just as in the previous chapter on foundations. In the case of bonds, the bond returns are based on the Barclays Aggregate index. In the case of stocks, both foreign and domestic stocks are included, with foreign stocks being one-fifth of the total stock allocation (as in the Vanguard Fund). Foreign stocks are represented by the Morgan Stanley EAFE index, while U.S. stocks are represented by the Russell 3000 index. So a 50/50 bond/stock portfolio consists of 50 percent in the Barclays Aggregate index, 40 percent in the Russell 3000, and 10 percent in the MSCI EAFE indexes.

As in Chapter 8, the returns on these three indexes are obtained using the premium method. The premiums are then applied to the historical returns on the basic capital market assets, the S&P 500 and medium-term Treasury bond measured over the period since 1951. The compound real returns on these assets were 2.4 percent for the Treasury ...