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

What’s the Best Global Allocation?

Question: About ten years ago, you recommended the following asset allocation:

40% US Total Stock Market Index Fund
30% European Stock Index Fund
20% Pacific Index Fund
10% Emerging Markets Index Fund

I see the 10-year average return for the Pacific fund is somewhat below the others. Do you still recommend this asset allocation?

Answer: Somebody once said that you know economists have a sense of humor because, when they predict future growth rates, they carry their answer out to two decimals.

I don’t want to pretend that there is pure science behind the selection of geographical asset allocations. The one I suggested as a possibility 10 years ago was, I believe, mainly designed to fit the least expensive ETFs at the time from Vanguard. Emerging markets, in particular, were extremely expensive to invest in through ETFs or other mutual funds. There was no good single ETF that took care of global allocation on its own. Nor were there global options using alternative indexing whose advantages I’ve discussed in previous blog posts.

A few weeks ago I mentioned that our family retirement money is virtually all in a single ETF, ACWV. I still think that’s an excellent choice. It actually comes reasonably close to my recommended allocation from a decade ago except that the continued underperformance of Japan puts it closer to 50-30-10-10 than 40-30-20-10. That is also reasonably close to the geographical allocation of the individual stock portfolios of most of my clients.

I will admit, however, that the client mutual-fund portfolios I typically design are usually closest to an equal allocation between the U.S. market, developed foreign markets, and emerging markets. The reason I don’t do this with individual stock portfolios is that it is difficult and expensive to directly invest in companies based outside the United States and the increasingly onerous regulatory requirements for listing on American exchanges seriously limits the foreign options. But it IS helpful from a diversification standpoint to weight emerging markets more heavily than in the past for two reasons:

  1. Emerging markets are now actually emerging and have a combined gross national product that exceeds the United States.
  2. The performance of emerging markets has often diverged strongly from that of U.S. companies, significantly improving the overall diversification of portfolios.

Of course, in 2013 the U.S. market soared while emerging markets suffered, but that’s just as much an example of good diversification as those years in the mid-naughties when U.S. stocks were weak performers and foreign markets the relative stars. I’m global because I’m ignorant: I just don’t know who will be the next to lead.

As for the underperformance of the Pacific Index over the past decade, this is all part of the continuing weakness of the Japanese stock market. But I expect every region to have its day in the sun.