by Archie M. Richards, Jr., CFP^®
September 1, 2003

Manuel, 45, raises a question concerning my recent column about asset allocation. (In www.archierichards.com, the column is dated June 30, 2003.) It recommends Vanguard index funds (800-523-7731), as follows:

Initial		Permissible
Percentages	Vanguard Funds	30 Percent Ranges
10%	Growth Index Fund - large growth	7 to 13%
10%	Value Index Fund - large value	7 to 13%
5%	Small Cap Growth Index - small growth	3.5 to 6.5%
5%	Small Cap Value Index - small value	3.5 to 6.5%
18%	Europe Index Fund	12.6 to 23.4%
7%	Pacific Index Fund	4.9 to 9.1%
5%	Emerging Markets Index Fund	3.5 to 6.5%
20%	REIT Index Fund	14 to 26%
20%	Long-Term Bond Index Fund	14 to 26%
100%

As the column suggests, invest money according to the percentages shown above on the left. Rebalance every 13 months as follows: If the percentage of a fund has changed by 30 percent or less from its original (see the permissible range of percentages above on the right), leave the fund alone. If the value has risen above the 30-percent range, sell some of it to return the percentage to the original, adding the proceeds to other funds that have performed poorly. If the value of the fund has fallen more than 30 percent from the original, sell other funds that have done well and bring this one back to the original percentage.

One of Manuel's children will reach college in 9 years; the other in 12. Manuel asks, "Should I increase my percentage of stocks from the 60 percent you recommend to, say, 80 percent. Should I then move toward bonds until college is finished, and finally back to the 60 percent allocation described in your column?"

No, Manuel. Except for tuition payments, 60 percent stocks is suitable all the time.

Stocks are marvelously profitable in the long term, but they're also volatile. Serious price declines occur, and will do so again. Those "bear markets" are always a surprise, and they always hurt. Few investors can stand the hurt and not sell. Most people react emotionally and get out, reducing their risk at exactly the wrong time.

I therefore include in my recommendations 20 percent long-term bonds and 20 percent real estate investment trusts. These segments act differently from stocks. When one group is falling, another may be rising, cutting the volatility of the entire portfolio. With rebalancing, the results should be almost as favorable as stocks alone. But the lesser fluctuations make bear markets easier to live with.

For the next 3 years, Manuel, add as much as you can to the asset allocation portfolio above.

But in year 4, five years prior to the start of college costs, place money in Vanguard's Short-Term Corporate Bond Fund, to protect the tuition money from a bear market that might occur during the five years. The interest on short-term corporates is higher than that of money funds. The principal value of the fund changes, but with the average maturity of the bonds only 2.5 years, the principal fluctuates only a little.

Set aside an amount that will grow to the tuition amount needed five years later. Take into account the interest the short-term corporate bond fund pays and any inflation of college costs you expect.

The amount set aside in year 4 will provide for the first year of college of your oldest child in year 9. If you can fund this short-term investment with money you're earning in year 4 from your job, fine. To the extent you can't, transfer funds from your asset allocation portfolio.

In year 5, put aside enough to provide the costs for years 10. In year 6, provide for year 11.

In year 7, set aside double, to provide for two kids in college in year 12.

In each of years 8 through 10, put aside enough to complete years 13 through 15.

Except for these known expenses, stick with my asset allocation program. Rebalance every 13 months. The long-term results should be excellent. But you can also sleep nights.