Last year I completed a Strategic Asset Allocation model.  The model calculates the optimal allocation to stocks, bonds, commodities, TIPS and REITS by evaluating the projected future return of each asset class against that investment’s projected price volatility.  The results of the model can be followed on my Portfolio page under the tab ‘Asset Allocation’.

First, here’s a view of the available investment yields currently offered to us by the major asset classes:

(Projected future returns are calculated using dividend-discount models and estimates from John Hussman, Jeremy Grantham, and Rob Arnott.)

There are no great bargains across the investment landscape right now.  All asset classes have a projected average future return below 2%.  The Bull Market and Central Banks have pushed available yields down to almost nothing.  Ideally, an investment would have its projected return AND it’s entire range of price volatility above the zero line.

The projected returns and price volatility are then fed into a model which uses the Kelly Formula to determine the optimal asset allocation.  Here are the current results:

In summary, we are increasing our exposure to TIPS and Emerging market bonds, while decreasing exposure to US treasuries, European and Emerging Market Stocks.  I am using low-cost Vanguard ETF’s to follow this strategy – the ETF symbols are in the chart above.  I’m using this in my 401-k but have to be creative and combine some of the asset classes based on the funds offered.

Some more detail on the model can be found in this article.  The accounts that follow this model are up an average of over 7% in the past year, not bad for a primarily bond and cash portfolio in this late stage of the stock bull market.  I will continue to respond to the opportunity set given by the markets.

This ‘Optimal Asset Allocation’ model will be updated twice a year – in April and October (these months are chosen based on the work of Sy Harding’s Seasonal Timing Strategy).