The Rule of 72 and Swensen’s Model of Asset Allocation
How Long Will it Take to Double Your Money?
This is a very good question. It is probably one of the most important questions to ask yourself when you have some disposable income saved up. So don’t worry, we will answer this question right now!
The Rule of 72 is a fast trick you can do to figure out how long it will take to double your money in investments. Here’s how it works: Divide the number 72 by the return rate you’re getting, and you’ll have the number of years you must invest in order to double your money. (For the math geeks among us, here’s the equation: 72 ÷ return rate = number of years.) For example, if you’re getting a 10 percent return rate from an index fund, it would take you a little more than seven years (72 divided by 10) to double your money. In other words, if you invested $5,000 today, let it sit there, and earned a 10 percent return, you’d have $10,000 in about seven years. And it doubles from there, too. Of course, you could accumulate even more using the power of compounding by adding more every month.
Swensen’s Model of Asset Allocation
As we discussed here, the key to constructing a portfolio is not picking killer stocks! It’s figuring out a balanced asset allocation that will let you ride out storms and slowly grow, over time, to gargantuan proportions. To illustrate how to allocate and diversify your portfolio, we’re going to use David Swensen’s recommendation as a model. Swensen is pretty much the Beyoncé of money management. He runs Yale’s fabled endowment, and for more than thirty years he has generated an astonishing 13.5 percent annualized return, whereas most managers can’t even beat 8 percent. That means he has almost doubled Yale’s money every five years from 1985 to today. Best of all, Swensen is a genuinely good guy. He could be making hundreds of millions each year running his own fund on Wall Street, but he chooses to stay at Yale because he loves academia. “When I see colleagues of mine leave universities to do essentially the same thing they were doing but to get paid more, I am disappointed because there is a sense of mission,” he says. I love this guy.
Anyway, Swensen suggests allocating your money in the following way:
30 percent—Domestic equities: US stock funds, including small-, mid-, and large-cap stocks
15 percent—Developed-world international equities: funds from developed foreign countries, including the United Kingdom, Germany, and France
5 percent—Emerging-market equities: funds from developing foreign countries, such as China, India, and Brazil. These are riskier than developed-world equities, so don’t go off buying these to fill 95 percent of your portfolio.
20 percent—Real estate investment trusts: also known as REITs. REITs invest in mortgages and residential and commercial real estate, both domestically and internationally.
15 percent—Government bonds: fixed-interest US securities, which provide predictable income and balance risk in your portfolio. As an asset class, bonds generally return less than stocks.
15 percent—Treasury inflation-protected securities: also known as TIPS, these treasury notes protect against inflation. Eventually you’ll want to own these, but they’d be the last ones I’d get after investing in all the better-returning options first.
Beginning your journey into investing should, ideally, start early. But, it’s never too late to start! In episode 120 of my podcast, we meet Ana and Gabriel, a young couple with 3 kids and very little saved for the future. There are some incredible money lessons here for all of us!
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A significant amount of math went into Swensen’s allocation, but the most important takeaway is that no single choice represents an overwhelming part of the portfolio. As we know, lower risk generally equals lower reward. But the coolest thing about asset allocation is that you can actually reduce your risk while maintaining an equivalent return.
Swensen’s theories are great, but how do we make them real and pick funds that match his suggestions? By picking a portfolio of low-cost funds, that’s how.
Choosing your own index funds means you’ll need to dig around and identify the best index funds for you. I always start researching at the most popular companies: Vanguard, Schwab, and T. Rowe Price; check out their websites.