New Computer Software Demonstrates Asset Allocation In Concept And
Practice

Creating a properly balanced and diversified portfolio is the goal of most
investors. For many, it is a challenging task--long-term investment
objectives, risk tolerance, and the current financial situation must be
considered before allocations to stocks, bonds, and cash reserves can
begin. Even if the "right" portfolio could be created, how might it
perform over various market cycles and in differing market conditions?

There is now an easy way to create and test a portfolio. The second
generation of The Vanguard Retirement Planner (version 2.0), now
available, features an interactive "Portfolio Planner" module along with
the original software designed to help you plan how much you need to save
for retirement. The new module helps you to determine your objectives,
time horizon, risk tolerance, and financial situation. It then suggests a
portfolio allocation and offers historical views of how that portfolio--or
a portfolio with any allocation of your choosing--would have performed in
any year or sequence of years since 1926. This article examines a scenario
for one individual, from initial planning to his portfolio's risk and
return characteristics.

Determining The Allocation

Consider Charles, a 38-year-old investor who plans to retire at 67. His
objective is long-term retirement planning, and his risk tolerance is
"moderate"--level 3 on the program's 5-point scale. Also on a 5-point
scale is an assessment of his financial situation--judged "secure and
stable." The software suggested an allocation of 80% equities and 20%would
have bonds, but Charles altered it to create a model portfolio that is 80%
equities, 15% bonds, and 5% cash reserves.

Applying The Allocation To Past Markets

How would Charles' portfolio have performed in past market conditions? The
Planner's "overview" function gives an instant display for any period
since 1926 using the following measures: for stocks, the Standard & Poor's
500 Index; for bonds, long-term Treasury bonds; for cash reserves,
Treasury bills. The best decade was the 1980s, in which all three asset
classes provided outstanding returns; the model portfolio's average annual
return was +16.5%. An all-equity portfolio would have returned +17.5%--but
the model portfolio earned 95% of that amount while assuming only 80% of
the equity market's risk. That is a good trade-off for an investor seeking
marketlike returns with tempered risk.

During the 1930s and 1970s, returns on cash reserves exceeded those on
equities, so the model portfolio's returns surpassed those of the equity
portfolio by 1.7% and 0.2%, respectively. But its average annual total
returns were a modest +1.6% in the 1930s and +6.1% in the 1970s.

Applying the model portfolio to the markets over the past 30 years, the
software presented the five best and worst single years, shown in the
table below. An all-equity portfolio's returns are provided for
comparison.

There is more to the software than can be explained here. For example, it
can chart a model portfolio's performance for each year since 1926. The
new version of The Vanguard Retirement Planner includes all of the
retirement planning modules of the critically acclaimed prior version and
runs on any IBM-compatible PC with at least 512K RAM, 1.2 free megabytes
of hard disk space, a VGA color monitor, and DOS version 3.0 or later.
(The program is not available for Apple computers).

Ordering Information

The Vanguard Retirement Planner is $15 (plus $2.50 for shipping). To order
by phone with a credit card, call 1-800-876-1840. To order by mail, mail
your check for $17.50, payable to "The Vanguard Group," to The Vanguard
Retirement Planner, P.O. Box 11004, Des Moines, IA 50336-1004. Indicate
whether you want the 3-1/2" or 5-1/4" disk. Your software will be mailed
in early February.

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