I set up Genevieve’s 529 account with Vanguard. I chose Vanguard for a couple of reasons. I liked the fact that I could pick my own asset allocation and my own Vanguard index funds. For something like a 529 account, I believe index funds are the way to go. I will be testing this theory because both of the benchmarks I have chosen are actively managed funds. Finally, I am familiar with Vanguard and its funds.
Next it was time to determine my asset allocation. Think of asset allocation as diversification. We know that you should not put all of your eggs in one basket. Asset allocation can be one of two things: You can allocate your investment among different types of securities, for example, stocks, bonds, and cash. Or you can allocate your investment within one type of security. For example, if you had a portfolio of stocks, you could diversify with portions in technology stocks, financial stocks, conglomerates, and energy companies.
I chose a 70%/30% stock/bond split. Given that I have only a 20-year timeframe (keep in mind that the last 10 years for stocks were essentially flat), a 70/30 split seems like the correct return vs. risk ratio for me. Below is a chart from an AAII (American Association of Individual Investors) article. Based on historical performance, a 70/30 stock/bond split has a significant reduction in risk (or price variation) without a significant reduction in overall return.
What is interesting is that the mix with the highest return with the least amount of risk is an 20/80 stock/bond split, which is also the lowest risk possible. This may be a good asset allocation to switch to once college gets a little closer.
Now that I had my asset allocation determined, I had to come up with a mix of Vanguard index funds for diversification within an asset class. For my stocks, I wanted 40% international and 30% domestic. I feel over the next 20 years there will be more growth overseas than here at home. For the U.S.-based stock, I split 15% into the Total Stock Market Index fund and 15% into the Small-Cap Index fund, thinking that over the next 20 years, small caps will outperform the broader market. For the bond portion, I put 15% in the Total Bond Market Index fund and 15% in my favorite fund, the High-Yield Bond fund.
Is this my ideal portfolio? No. It is close, though. Vanguard limits you to five funds. I would love to add three more funds. To see what they are, click here [link to be added].
The real secret to this portfolio is the rebalancing. Every month I am going to check to see if any one or two funds have grown to a point that they are 5% higher than the initial holdings. If so, I will sell off the “profit” and add it to the other funds to get the asset allocation back to 70/30. Over time, this “buy low, sell high” strategy should even out and yield some nice overall returns.