I'm only interested in allocating funds between cash, bonds and stocks.  So I took a look at the total yearly returns for cash (3-month US Treasury bills), long-term bonds and stocks (S&P 500 Index) for each year beginning with 1926.  Ranking simply by which class came out on top in each year, I came up with:

• 58% stocks
• 24% long-term bonds
• 18% cash

A more conservative approach, which assigns a value of 3 to the top-performing asset class in each year, 2 to the one in second place and 1 to the one in third place yields the following allocation:

• 38% stocks
• 32% long-term bonds
• 30% cash

That's a BIG difference!  I use the former (more aggressive) allocation because I have other funds that are invested to insure that I will have enough income to meet my minimal needs regardless of how the more aggressive assets perform.  If you don't, you might want to adopt the more conservative approach.

Using that more aggressive allocation, I invest the 18% cash allocation in 1 or 2 money market funds; the 24% long-term bond allocation in 1 or 2 funds with an average maturity of about 20 years or so and an average credit quality of "A" or better; the 58% stock allocation in a maximum of 7 funds.  What I try to find for the stock allocation are both growth and value funds in each of the large-cap, mid-cap and small-cap categories, plus 1 international fund, that score high in my rankings.  Where I can't find a high-scoring growth or value fund in any category, I substitute a "core" fund.  If I can't find one of those either, I substitute a multi-cap fund.  But in making any substitutions, I make sure that I don't wind up with a total number of growth funds that is more than 1 higher or lower than the number of value funds.

Now I've selected investments that allow me to be diversified across asset types (stocks, bonds and cash) and, within the stock class, by investment approach and company size.  But how do I select how much to invest in each stock fund?  First, I add up the scores for each fund I've selected.  Then, I multiply 58 times the score for any particular fund and divide by the total for all funds I've selected.  That gives me the percentage of my total investable assets to be allocated to each individual stock fund.

Now for a key part of my method: I always specify that all dividend and capital gain distributions from bond and stock funds are invested in a money market fund, not reinvested in the fund that is making the distribution(s).  I know, this is contrary to most suggestions, but what it does is take some money off the table when I have good performance so I don't get overweighted in that particular category.  Then every month (you could choose to do it every 3 months, 6 months or yearly), I do the following:

1. If I have over 60% in stock funds, I transfer the excess over 58% to a money market fund by selling off the portion of any funds that have a current value above their allocation percentages.
2. If I have over 26% in long-term bond funds, I transfer the excess over 24% to a money market fund.
3. Then I take the total of all the dividends and transfers into my money market funds, plus any additional funds I want to invest, and allocate 58% of that to my stock funds (those that have less value than my normal allocation would suggest) and 24% to my long-term bond funds, making sure that I won't have more than 58% in stock funds and 24% in long-term bond funds after the reallocation.  Any excess in either category remains in my money market fund(s).

I try to schedule any purchases for the next-to-last business day of a month and sales for the 4th business day of the following month.  The reason is that I saw a study several years ago that found the 5-day period from the last business day of a month through the 4th business day of the following month was the best period to be holding stocks.  Even if this doesn't hold true in the future, I figure that being consistent on when you make investments and withdrawals is probably a benefit.

So what does this accomplish?  First, it keeps me from getting too overallocated in any one class of assets.  Second, it keeps me from transferring too much money to any one asset class that might be in a long-term downtrend.  Third, it allows me to build up liquid assets in good times that I can draw on in bad times, because the dollar amount (but not necessarily the percentage) in my money market funds never really decreases unless I choose to make withdrawals.

For example, if the stock and bond markets have been in a prolonged uptrend, I will probably be transferring funds from those asset classes to my money market fund(s) in order to maintain my 58%/24%/18% stock/bond/cash allocation.  On the other hand, should those markets enter a prolonged downtrend, although I'll keep adding funds to them, it probably won't be enough to offset their declines, so I'll wind up with a greater percentage of assets in money market funds.  Only when those markets begin to stabilize, or rise, will my percentage of assets allocated to them begin to increase back toward my normal allocation.  To some extent, I'm following the philosophy of "selling in haste and buying at leisure".

Last revised: February 27, 2004