Being wealthy doesn't mean having all the money in the world, just not having to worry about it.

Hedging Against Volatility

Question: 1) Does it make sense to split the global equities allocation between the Minimum Volatility Fund and whole-world allocation (e.g., Vanguard’s Total World Fund [VTWSX]) to increase long-term return in exchange for a little more volatility?

2) Can your current recommendation for 10% in cash equivalents serve as your previous 2-3 years’ reserve against bear markets during retirement?

Thanks so much.

Answer: (1) Both the market-weighted Total World Fund and the alternative-weighted Global¬†Minimum Volatility Fund provide adequate diversification in my view. In that sense I am comfortable with any division between the two for the equity portion of the portfolio. Some people will be limited in their choice of investments and will need to cobble together their own global equity fund by investing in funds that cover different parts of the world. These people will end up with overall allocations that differ from both of the funds mentioned. I don’t think it is a key issue.

So knock yourself out if you think the additional volatility of the traditional market-weighted fund will be rewarded. Frankly, the historical evidence doesn’t support this theory, and I think there are various theoretical reasons — such as the lottery premium and leverage constraints — why more-volatile stock portfolios should not be expected to have higher returns. (For those who, like me, actually enjoy extremely academic discussions of the theory of investing, see Expected Returns by Antti Ilmanen.) Just make sure that, one way or another, you are spreading your equity bets and not overinvesting in one geographic area or industry.

(2) You are correct: since withdrawals are generally going to be limited to 4-5% a year from a portfolio intended to last a long time, my reference to a 10% reserve was intended as an alternative way of describing a 2-3-year bear-market reserve.