Should I manage my asset allocation by style or market cap?

Question

There are some sources (eg. The Complete Idiot's Guide to Making Money with Mutual Funds) that suggest a portfolio based on style (eg. value, blend, growth) such as

• 30% growth mutual funds
• 30% value mutual funds
• 30% bond mutual funds
• 10% cash/money market funds

And other sources (eg. CNNMoney.com) that suggest a portfolio based on market cap such as:

• 50% large-cap stocks
• 20% small-cap stocks
• 30% bond funds

I understand that many combinations of value, growth, small-cap, and large-cap are possible, but it can be difficult to track percentages within each fund. Any recommendations on the right strategy to use?

Answer 1

I would recommend using growth/value/income/bond based asset allocation because your goal is to find asset classes that have different performance trends (when 1 is up, the other is down and vice-versa).

If you chose Domestic, US stocks and diversified between Med Cap and Large Cap stocks, they would not exactly mirror each other, but they would roughly rise and fall at the same time, preventing you from taking full advantage of diversification, increasing risk and lowering returns.

Answer 2

You have to look at the market conditions and make decisions based on them. Ideally, you may want to have 30% of your portfolio in bonds. But from a practical point of view, it's probably not so smart to invest in bond funds right at this moment given the interest rate market.

Styles of funds tend to go into and out of style. I personally do asset allocation two ways in my 457 plan (like a 401k for government workers):

1. First, I allocate by Large/Mid, Small, International and Cash
2. Second, I allocate by styles within the larger categories and often by the fund. I don't like index funds and I don't like very large mutual funds as they tend to be inflexible.

In my IRA, I invest in a portfolio of 5-6 stocks.

The approach you take is dependent on what you are able to put into it. I invest about 10 hours a week into investment related research. If you can't do that, you want a strategy that is simpler -- but you still need to be cognizant of market conditions.

Answer 3

It doesn't matter which way you use. As long as your comfortable with the overall level of risk/reward in your portfolio, that's what matters. (Though I will say that there are more investment vehicles than stocks, bonds, and cash that are worth considering.)