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If you are trying to figure out an asset allocation to use in your own portfolio, pension funds are good places to look for ideas. In fact, some experts suggest that individual investors would be wise to follow the lead of the pension plans. The reasons are pretty simple if you think about it.
First, pension plans are invested for the best balance between risk and reward. The cannot be too risk adverse, or they run the risk of not being able to meet the future withdrawal requirements of the fund that it’s participants will require when they retire. They also cannot take on too much risk, or they run the risk of the portfolio blowing up and once again, not being able to meet the needs of future withdrawals from the fund. Thus, pension plans have invested a great amount of resources in determining what the best asset allocation is given their requirements, which leads us to the second reason investors would be wise to follow the pension plans as a guide – some of the best minds in finance work for pension plans.
The second reason for understanding what the pension plans are doing is that they employ some of the best minds in finance and their strategies are typically deeply routed in theory and best practices. These people are not the mutual fund managers that you are used to seeing – they are not sales people. Instead they are doctorates and other highly educated academics that have done complex research on what works best in investing. Since I don’t have this background or expertise, I like to look at what they are doing to learn best practices.
The Asset Allocation Research
I did some looking around the web and identified an interesting study completed by the folks at Mercer, who are a large advisory firm to human resources departments. Mercer advises on things such as compensation, benefit plans, and in our case pension plans. In one particular report (pdf) they provided a breakdown of the pension plans utilized by companies within the S&P 500. Here is what that asset allocation looks like:
Click to EnlargeAs you can see, there is not an overwhelming portion of this portfolio in equities. Fixed income makes up a large component. I would like to see how these funds breakdown their equity components – domestic, global, emerging, etc. I was unable to find that detail in this report but will keep looking.
Is this a good guide for most investors? I would suggest that it is a great place to start. There are good reasons these pension plans have chosen this target asset allocation. If you are looking for additional readings on choosing the right asset allocation, be sure to take a look at William Bernstein’s books on the topic.
(Photo Credit: Steve Woods)
Very interesting read, thanks for sharing it!
Best Wishes,
D4L
The only I would caution is that pension funds may have a longer investment horizon than a given reader. Ensure whatever asset allocation you select is suitable for your specific situation.
The only thing I would caution is that pension funds may have a longer investment horizon than a given reader. Ensure whatever asset allocation you select is suitable for your specific situation.
There are literally 100’s of asset allocation models on the net. Most bank/investment sites have something that you can key in a few data points and it will kick out an allocation. Probably a great place for the average investor to start and at least get the breakdown of foreign/domestic/sector equity components you mention is lacking from the pension slide.
You can try the “Investor Profiler” here…shows BMO specific funds but the output can be used anywhere.
http://www4.bmo.com/investments/0,4629,35649_24103457,00.html?pChannelId=24103457
I have to agree that pension plans make a great model for people starting out and they have no idea what their asset allocation should look like.
I think pension plans are a good model for retired investors. Bear in mind that pension plans are paying out current benefits so they must keep their volatility down. A working individual who is contributing to an investment account can maintain a higher equity exposure, if it is consistent with their risk tolerance.
People can’t rely on employers for their retirement, pensions should be a priority and the earlier you start contributing, the better off you will be in retirement.
non-retired individuals should start their thought process like a defined benefit plan instead of a defined contribtion. figure out what their magic number is to retire. then they can back into a needed rate of return range. what most will find is that many pension funds typically look for ~7% returns which is why their exposure to fixed income is high and equities low compared to what a personal financial advisor would recommend. in short, take a pension fund allocation and be more aggressive the younger you are in your investment cycle. also look out for asset trends. fixed income kills it in some markets and equities die. do your homework bottomline
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