Showing posts with label asset allocation formula. Show all posts
Showing posts with label asset allocation formula. Show all posts

Tuesday 28 April 2020

Buy and Hold? Really? Depends on your AGE and NEEDS

How should you choose between stocks and bonds?

Financial advisors are risk averse.  Their risk aversion may have less to do with your financial situation than their reputations.  Conventional wisdom is that a portfolio that is invested one-third in bonds and two-thirds in stocks is the way to go irrespective of the level of your assets.  The one-third, two-thirds formula is the standard.  It is safe because that is what the herd recommends.

The conventional model of portfolio construction, the one-third bonds two-thirds stocks, requires that you periodically rebalance your holdings.  By this, they mean that if your stocks had a particularly great year and now are 75% or 80% of your portfolio, you should sell some stocks and invest the proceeds in more bonds.  That is like selling your winners and reinvesting in your losers

  • How smart is that?  
  • If you already have enough cash to ride out three down years, why do you need more?


The major brokerage houses issue "asset allocation" formulas depending on their view of the stock market in the near term.  This sounds like market timing.  
However, people are different.  Your financial assets and your needs vary tremendously.  

  • What if you have a lot of dollars and need only a pittance to maintain your lifestyle?  
  • Why would you invest one-third of your money in an under-performing asset?



The two most important considerations in formulating an asset allocation formula are:

  • age.  and
  • how much money you have to support your desired lifestyle.




Jeremy Siegel's book - Stocks for the Long Run

In every rolling 30-year period between 1871 and 1992, stocks as measured by an index, beat bonds or cash in every period.  

In rolling 10-year periods, stocks beat bonds or cash 80% of the time.  

Bonds and cash did not beat the rate of inflation over 50% of the time.  



So why would anyone own a bond?  The answer comes back to age and need.

If you are young (20 years to 35 years) and have a job that pays your bills, you can take a long view on investments.

A lot of what you do in investing is just simple common sense.  Many investors think they should be proactive and keep looking for ways to tweak their investment portfolio when just sitting tight, if they made the correct choices in the first place, often would be the better course.





Examples: 

Asset allocation is based on age and need.

1.  A friend liquidated an asset and wished to invest in the stock market.  However, he will need this money for a project he is working on at end of the year.   He should not invest this money in stock, as his need for the money did not anticipate any setback in the stock market.  If he could not be in for the long term, he should not be in.

2.  In early 1980s, a widow inherited a $4 million account with an investment firm and in addition $30 million of Berkshire Hathaway stock.  She anticipated retiring and needed some income going forward.  She had lived comfortably but modestly, given her wealth.   The reason she was so rich was because all her assets had been well invested in stocks Her accountant replied that she had all her assets in the stock market which was, by definition, risky. He suggested a charitable remainder trust into which she could put the Berkshire stock, sell it without paying any capital gains taxes, and reinvest the proceeds in bonds for current income.   On the other hand, her investment advisor replied even if the stock market dropped 50%, she had enough money to live comfortably until her very old age and asked why she would want to stop enjoying the benefits of future appreciation. She decided to leave everything as it was and received her income needs out of the money she had invested with the investment firm.   A number of years later, she reviewed her plan.  She had $180 million.  Today, she has upward of $300 million.  


Friday 26 June 2009

Asset Allocation is not the same as Diversification

Asset allocation is not the same as diversification.

Rather, it refers to the strategy of allocating your investment funds among different types of investments, such as stocks, bonds, or money-market funds.

  • In the long run, you will be better off with all of your assets concentrated in common stocks.
  • In the short run, this may not be true, since the market occasionally has a sinking spell.
  • A severe one, such as that of 2000-2002, can cause your holdings to decline in value 20% or more.
  • To protect against this, most investors spread their money around.

They may for instance,

  • allocate 50% to stocks, 40% to bonds, and 10% to a money-market fund, or,
  • a more realistic breakdown might be 70% in stocks, 25% in bonds, and 5% in a money-market fund.


Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Thursday 25 June 2009

A Simple Approach to Asset Allocation

Serious investors spend a lot of time deciding which stocks or mutual funds to buy. This is appropriate. If you are going to invest your money, you shouldn't do it without some research and thought.

On the other hand, some financial gurus maintain that it is far more important to make an effort to achieve an effective approach to asset allocation. They believe that you should place your emphasis on how much of your portfolio is invested in such sectors as:

Government bonds
Corporate bonds
Municipal bonds
Convertible bonds
Preferred bonds
Large-cap domestic stocks
Small-cap domestic stocks
Foreign stocks
Foreign bonds
Certificates of deposit
Annuities
Money-market funds

There are probably a few other categories you could include in your portfolio, and examining this list gives you an idea of what is meant by asset allocation.

The importance of asset allocation is in understanding how it can help or hurt you during certain investment periods.


A Simple Approach to Asset Allocation

From the above, you can see that asset allocation, like everything else in the world of finance, can get rather complex and confusing. It is no wonder that many people don't delve into this too much.

Here is one such approach by an investor.

"My idea of investing is to make it simple. There are just so many hours in the day. If you are still gainfully employed, you probably work eight hours in the day making a living. In the evenings, you may spend a few hours a week reading journals and other material so that you don't get fired. Obviously, that doesn't leave much time for studying the stock market.

For my part, I don't invest in many small-cap stocks, foreign stocks, bonds, convertibles, preferred stocks, or most of the other stuff on this list. I prefer to invest mostly in big-cap stocks (such as ExxonMobil, GE, Merck, IBM, Procter & Gamble, and Johnson & Johnson) and money-market funds (a safe alternative to cash).

This reduces my categories to two (2), not a dozen. All you have to do is decide what percentage of your portfolio is in stocks. The rest is in the money-market fund. Of course, the percentage is vitally important."



Related posts:Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Forget about Everything Else and Buy Only Stocks

Believe it or not, there are some investors who are convinced that common stocks - and common stocks alone - are the royal road to riches.

"A good friend of mine has never bought anything but stocks, and he's been doing it for many years. He even went through the severe bear market of 1973 - 1974, when stocks plunged over 40 percent. He wasn't exactly happy to see his stocks being ground to a pulp, but he hung on. Today, he is a millionaire many times over. He's now 60 years old, still a comparatively young investor. His name is David A. Seidenfeld, a businessman in Cleveland."

David Seidenfeld got his start by listening to the late S. Allen Nathanson, a savvy investor who wrote a series of magazine articles on why common stocks are the best way to achieve great wealth. David Seidenfeld recently collected these essays and published them as a hardcover book, Bullishly Speaking.

If you start investing early, such as in your forties, this method can work. If you systematically invest, setting aside 10 or 15 percent of your earnings each year and doing it through thick and thin, you won't need any bonds, money-market funds, or any of the other alternatives that financial magazines seem to think you must have. You will arrive at retirement with a large portfolio that will enable you to live off the dividends.

However, if you arrived late to the investment party - let's say in your late 50s or early 60s - you may not be able to sleep too well if you rely entirely on common stocks. After all, stocks have their shortcomings, too. They tend to bounce around a lot, and they can cut their dividends when things turn bleak.


Read also:

The story of Uncle Chua
Uncle Chua's Portfolio & Dividend Income

and

Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Some asset allocation options to consider

For the ultraconservative investor, a suggestion is for you to invest only 55% of your portfolio in common stocks. To be sure, when the stock market is marching ahead, as it has in the 90s, you won't be able to keep pace. But if it falters and heads south for a year or two, like recently, your cautious approach will keep you out of the clutches of insomnia.

Generally, such an approach is considered timid, and is not the best way to approach asset allocation. However, many are using this formula and are not complaining.

A better way to handle the uncertainty is to invest 70% in stocks, with the rest in a money-market fund. Once you decide on a particular percentage, stick with it. Don't change it every time someone makes a market forecast.

These market forecasts don't work often enough to pay any attention to them. No professional investor has a consistent record in forecasting. Every once in a while, one of these pundits makes a correct call at a crucial turning point, and from that day on, every one listens intently to the pronouncements of this person - until the day the pronouncement is totally wrong. That day always come.



Related posts:Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

How Much Should You Invest in Stocks?

When it comes to deciding on the percentage you should devote to common stocks, there are several alternatives that should be considered. All have some merit, and none are perfect.

In fact, there is no such thing as a perfect formula for asset allocation.

It depends on such factors as


  • your age, and
  • your temperament.

It might also depend on what you think the market is going to do.


  • If it's about to soar, you would want to be fully invested.
  • But if you think stocks are poised to fall off the cliff, you might prefer to seek the safety of a money-market fund.

Related posts: Some Simple Formulas for Asset Allocation

A favourite Formula for Asset Allocation

Age is the key to asset allocation. The older you are, the less you should have in common stocks.

If you are age 65, you should have 65% in common stocks, with the rest in a money-market fund.

If you are younger than 65, add 1% per year to your common stock sector. As an example, if you are 60 years old, you will have 70% in stocks.

If you are older than 65, deduct 1% a year. Thus, if you are age 70, you will have only 60% in stock.

Here is a table breaking down the 2 percentages by age:

Age--Stocks--Money-Market Funds

40---90%---10%
45---85%---15%
50---80%---20%
55---75%---25%
60---70%---30%
65---65%---35%
70---60%---40%
75---55%---45%
80---50%---50%
85---45%---55%


Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation