Allocating Your Assets

By Jon L. Ten Haagen

Someone explained it to me as: If I had $100 in singles and I had three buckets in front of me to put them in, No. 1 for equities (stocks), No. 2 fixed income (bonds, CDs) and No. 3 being cash (totally liquid), how many dollars would I put in each bucket? If you are younger and have many years until retirement you would most likely put the most dollars in the stock bucket, a small amount in the bond bucket and a very small amount in the cash bucket.

As you get older and closer to retirement, you should think about changing the amount of bucks in the buckets. Perhaps reducing to 60 percent in stocks, 30 percent on bonds and 10 percent in cash. This is because you have fewer years until retirement and you want to cushion in case the markets have a large correction, which is inevitable at some point in time.

Then as you enter retirement you may be more comfortable making another shift in which you have 40 percent in stocks, 40 percent in bonds and 20 percent in cash.

Now, I hear too many people who are within a few years of retirement talking about moving all their assets into fixed income and cash to be safe. They do not take into consideration the effects of inflation and taxes on their portfolio. Remember, if you retire around the age of 65, statistically you are expected to live another 20 or more years. Without some growth in your portfolio inflation will take a large bite of your funds.

Creating and following a form of these allocation models can have a major effect on reaching your financial goals. There are very valid reasons that asset allocation is critical to sound investing:

• No single type of investment produces the best return year in and year out. Look up a Callahan chart and you will see how various categories if investments can change radically from one year to the next. I have seen a category be the top performing stock one year and literally be the very worst the very next year, then back up near the top again.

• Bonds produce better returns in some years and weaker in others. They are usually driven by interest rates. Interest rates are at their lowest in decades, so be careful when you are looking for fixed income in your portfolio. Look at the years until maturity of the bond, whether it is trading at a discount or premium and the rating of the issue.

• Cash usually provides the smallest but most consistent returns. Consider having cash for those things you want to buy in 2-3 years and you must have that money.

These results reflect the performance of an entire asset class, or group of investments. They do not report the return of any individual stock or bond.

There is evidence on the importance of asset allocation; financial experts have devised some formulas called models for dividing up your overall portfolio. Don’t be confused if you encounter a range of suggested allocations. Brokerage firms and other advisors often modify their recommendations regularly, usually in small increments, in response to changes in the economy. Any allocation model can be modified to suit your goals, your tolerance for risk and your time frame. These asset allocation models are guides to give you a start and then you and your advisor can adjust as you see fit going forward.

Knowing the intelligence of having an allocation model to guide you is wise; sticking to it is often very difficult. As your portfolio grows with a good stock market the allocations can be can be thrown off. The stock portion may be bigger than the original allocation, so you should consider selling the profitable portion of the stocks and reallocation that money into one of the areas (bonds and cash) which have not grown. This way you take the profit (selling high) and putting it to work in an area which could grow on a different market move.

When you dollar cost into your portfolio, you should add money to the buckets in the percentages you have. For example, if you have an allocation of 60 percent stocks, 30 percent in bonds and 10 percent in cash and you are going to add $1,000 to the portfolio, you put $600 into the stocks, $300 into the bonds and $100 into the cash. This way you keep the asset allocation you want.

Most people who have smaller amounts to add to their portfolios may consider mutual funds rather than individual stocks. You will get a better diversification to your portfolio. Talk to your certified financial planner about considering alternative investments to add more diversification. Real estate, international securities, etc.