Securing Your Future With Asset Allocation
By Steven Samblis
Let me ask you a question. What is the hardest part about investing in the stock market? I ask this question at the beginning of my seminars and I hear the same thing over and over again. It's not picking the right stocks or the right broker. The hardest part about investing in the stock market is just getting started. Lets face it, you can go out and get a plethora of magazines and newspapers that talk about where the market is now, but nobody explains the steps to get started. No one says to you, "Here is step A, B, C, etc". What I would like to do for you today is give you the steps to get started in the right direction. Even if you are currently invested in the stock market and doing OK, following these steps will make you a more successful investor. It's never too late to begin investing the right way.
The first thing you need to do when investing in the stock market is to determine your time. In other words, make a determination of how much time you have for your pool of assets. What does this mean? If you determine you have five years for your portfolio, that you need your money back in five years, studies say you should have 50% of your money in stocks and 50% in bonds. If you feel that you have five to ten years then the studies say you should have 75% of your money in stocks and 25% in bonds. If you decide that you have more than ten years, studies show the best asset allocation is 80% of your money in stocks and the balance in bonds.
You may ask, why do time parameters make a determination on my asset allocation. The answer to the question is simple. Look at the market since inception, when people talked with telegraphs instead of telephones. There has never been a ten-year period in the market that stocks did not show a positive return. If you say to me that you have ten or more years to invest, are the odds with you? Of course they are. If you have five or less years the odds aren't as much in your favor.
Why not put all my money in the stock market? That's where the big money is being made. On the surface this may seem the right path, but it is way off. Stocks are an asset class. Bonds are an asset class. Cash is an asset class. Having only one asset class in a portfolio is always more risky then two. Two asset classes diversify your risk. If the second asset class is a higher returning asset class, you not only reduce your risk, but also increase you returns. This means, if you have a 100% bond portfolio and change it to 90% bonds 10% stocks, you will reduce your risk and increase the portfolios total return. Yes! Less risk more return!
For the purpose of this column I will use the example of an individual that says he has five to ten years before he needs to touch his money. With this person we have 75% of the portfolio in stocks and 25% in bonds.
Let me make a quick point. When stocks are going up in value, bonds are usually falling in value. The inverse is also true. When the stock market is falling, bonds increase in value. The reason for this is what some call "the flight to quality". This is especially clear to see during large market drops. When stocks are really falling out of bed, bonds are going up in value. This is because the institutions that make up most of the market have to put their money somewhere. When they sell stocks they put the cash into bonds. The influx of money into bonds affects the supply that is left, and the prices of bonds go up.
There are no mysteries to the stock market. Stocks and bonds only go up in price when people buy them. They also only go down when people sell them. A student once told me I was wrong about this last statement. He said, "Earnings and good or bad news makes stocks move". This is a common misconception, which can be easily clarified. It is not earnings, or good or bad news that moves stocks. When you read bad news on company XYZ you may sell your XYZ stock. If the news is bad enough a lot of people will sell XYZ and the selling will make the stock fall. If XYZ had terrible earnings or lost a big lawsuit, and nobody knew about it, nobody would sell. The stock would not move. If a tree falls on Wall Street and nobody hears it, does it make a sound? The answer is no!
So, Bonds are up - Stocks are down. Stocks are up - Bonds are down. Are you with me? Good.
The next thing that must be determined is what you need your portfolio to do now. As an example you might be looking for growth. Another person with the same time parameters may need some income from their portfolio. We need to address this. In the stock market there are sectors, and each sector acts a different way. For example, there is a utilities sector. These are utility company stocks. Historically, utility stocks pay dividends (quarterly income payments to shareholders of record).
If you decided that you need income from your portfolio, you would invest in stocks in sectors like the utility sector. This way you have stocks that pay dividends (income). Keep one thing in mind, if a stock pays dividends it will not offer the same growth potential as a stock that doesn't pay dividends. Dividend paying stocks are historically more stable than growth stocks. They don't move as much. They do move, but just not as much. There is a trade off.
If you decide that you are interested in growth, you would invest in sectors that historically don't pay dividends. You will buy stocks in sectors like the chip sector, where stocks have seen upward price momentum.
We have covered two steps up to this point. We determined time and current need. The following step is where most people will lose all their money. This is the step in which most people will get killed if they do it wrong. This is the step of managing your portfolio. I'm going to walk you thru a three - month example of managing your portfolio the right way.
You started your portfolio with 75% of your money in stocks and 25% in bonds. Thirty days have gone by and the stock market has been cranking. Stocks are going up and bonds are moving down a little. Your stocks are high and they are growing in value. Bonds are low. Now, you have a problem. All of a sudden percentage-wise you have too much money in stocks. You need to get back to 75/25. Lets say you have $2,000 too much invested in stocks. You will take sell $2,000 worth of stocks, and put that money into bonds. Now you are back to 75/25.
Thirty more days go by, and the market has been spectacular. Stocks are high and bonds are low. Suddenly, percentage-wise, you have too much money in stocks again. This time you have $3,000 too much invested in stocks. You need to sell $3,000 in stocks and buy $3,000 worth of bonds. This takes you back to 75/25. Your portfolio is growing, but it is doing so uniformly.
Thirty days more go by in the market and we see something that we have never seen before. Stocks go down. (Never saw that before, Huh?) Percentage-wise you have too much money in bonds. This time you have $1,000 too much in bonds, because they have gone up in value. You will sell $1,000 in bonds while they are up and buy $1,000 in stocks while they are down.
That was three months in the market I just showed you. Do you realize what you just did during these three months, without emotion and without really having to think about it too much? Let me give you a hint. You always hear the same thing, how do you make money in the stock market? Buy. Where? Sell. Where? Buy low - Sell high.
Lets talk about what you just did in the above example. The first month, after thirty days went by, what happened? Stocks went up. What did we do? We sold. Thirty days latter stocks went up again. What did we do? We sold. Thirty days more goes by, and stocks dropped in price and what did we do? We bought. We bought while stocks where cheap.
The example I used here really happed in the stock market. What I just showed you happened in 1987. It occurred in August, September and October of 1987. In August of 1987 stocks were cranking. In September of 1987 stock where doing great, and everyone in the market was making money. Do you remember what happened in October of 1987? The market went down and most people where panicking and selling. Utilizing this asset allocation strategy would have allowed you to buy stocks at some of the best prices in the history of the market. You would have done so without emotion and without panicking.
What you just learned seems simple. Don't let it trick you. The strength of the asset allocation system is in its simplicity. Follow the steps and you will get that much closer to your dreams. |
