With a simple portfolio and a simple strategy you can successfully invest and achieve a comfortable retirement without becoming a financial expert.
Simplicity is the key to success.
1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio
Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions was discussed in Part 3; next up – simplicity in increasing contributions over time.
4. Simplicity in Increasing Annual Contributions Over Time
A simple and painless way to increase your 401k contributions is to save a portion of every raise you get.
For example; assume you started with a 3% payroll deduction to your 401k. A year later you receive a 3% raise; so you increase your 401k contribution percentage from 3% to 4%. You keep the balance of your raise to increase your lifestyle a bit.
The following year you get another 3% raise and you increase your 401k contribution by another 1% from 4% to 5%. After 10 years, your 401k contributions are up to 13%.
You can continue this sequence until you are contributing the maximum allowed by law and still increase your standard of living every year – just not as much as the entire raise would have supported.
On the other hand – if you start early enough - your retirement will be not only secure but very pleasant.
Similarly, if your simple portfolio is in a Roth IRA, you can set your account transfers at some initial amount and increase the amount with each pay raise.
In this case, you will deal in actual dollar amounts – not percentages of your pay.
For example; assume your initial account transfer to your Roth IRA cash account is $100 per month. For the first year you contribute $1,200 and then you get a raise of $200 per month.
You will increase your transfer into the Roth from $100 per month to $200 per month and pocket the other $100 of your raise. Don’t forget to increase the monthly buy (exchange) amount so the money actually goes into your simple portfolio and doesn’t accumulate as cash.
The following year you contribute $2,400 to your Roth and you get a $300 per month raise. So, you increase your account transfer into the Roth from $200 to $350 and pocket the remaining $150.
The next year your contribution is $4,200 – closing in on the maximum allowed $5,000 per year contribution.
When you get your next raise you increase your transfer to $416.66 per month and contribute the maximum $5,000 per year – until the legal limit is increased, then you will again increase your contribution.
Successful investing for retirement can be simple.
The next post will discuss simplicity in rebalancing your portfolio.
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
Friday, October 23, 2009
Friday, October 16, 2009
Structuring Your Simple Portfolio: Part 3 – Simplicity in Contributions
There’s a lot to learn and know about investing. But, you can successfully invest and achieve a comfortable retirement without becoming a financial expert. With a simple portfolio and a simple strategy you can succeed.
For beginners, and for the uninterested, simplicity is the key to success.
1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio
Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series; next up – simplicity in making account contributions.
3. Simplicity in Making Account Contributions
Absolutely the simplest way to make contributions to your simple portfolio is through payroll deductions to your employer’s 401k plan.
When you establish your 401k account you will also choose a percentage of your gross income that you want to contribute to the plan. Then every payday an amount equal to the percentage of your gross pay (before taxes and other deductions) for that pay period will be withheld and contributed to your 401k account.
The contributed money will be allocated to the chosen investments of your simple portfolio. In the case of a Target Year Mutual Fund 100% of your contribution will be applied to the mutual fund. If you are using an Equity Index Fund and a Bond Index Fund your contribution will be allocated to each according to the allocation percentages you chose when you set up the account.
In Part 2 of this series, I suggested an allocation of 60% to the Equity Fund and 40% to the Bond Fund.
Some employers automatically enroll new employees in the company 401k plan with a pre-selected portfolio and a pre-selected contribution percentage.
Don’t count on that, though. And, even if your employer did enroll you automatically, check it out and make sure your enrollment conforms to one or the other of the simple portfolios.
If your simple portfolio is in a Roth IRA you don’t have the option of contributing through payroll deductions. So, you have to create an effective substitute. The way to do that is:
A. Have your pay direct deposited to a checking account
B. Set up a weekly, monthly or twice monthly automatic transfer from the checking account to your Roth IRA cash account.
C. Set up a monthly purchase of your chosen simple portfolio investment(s) using the money in the Roth IRA Cash account.
Each investment option under the Roth IRA umbrella is assigned its own account number. Cash contributions will probably have to be initially received in a cash account or money market fund which will be one of the investment options under your Roth IRA umbrella.
Then, you will buy or exchange into the Target Year Mutual Fund (100%) or into the Equity Index (60%) and Bond Index (40%) Funds from the cash or money market account.
This is more complex to set up but your bank or Vanguard account representative will do the heavy lifting if you ask.
In either simple contribution scenario above, once you have the payroll deductions or account transfers set up, the whole thing will run on automatic pilot. Just read your monthly and quarterly statements to ensure everything is still running and to watch your balances grow.
Successful investing for your retirement can be simple.
The next post will explain simplicity in increasing annual contributions over time.
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
For beginners, and for the uninterested, simplicity is the key to success.
1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio
Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series; next up – simplicity in making account contributions.
3. Simplicity in Making Account Contributions
Absolutely the simplest way to make contributions to your simple portfolio is through payroll deductions to your employer’s 401k plan.
When you establish your 401k account you will also choose a percentage of your gross income that you want to contribute to the plan. Then every payday an amount equal to the percentage of your gross pay (before taxes and other deductions) for that pay period will be withheld and contributed to your 401k account.
The contributed money will be allocated to the chosen investments of your simple portfolio. In the case of a Target Year Mutual Fund 100% of your contribution will be applied to the mutual fund. If you are using an Equity Index Fund and a Bond Index Fund your contribution will be allocated to each according to the allocation percentages you chose when you set up the account.
In Part 2 of this series, I suggested an allocation of 60% to the Equity Fund and 40% to the Bond Fund.
Some employers automatically enroll new employees in the company 401k plan with a pre-selected portfolio and a pre-selected contribution percentage.
Don’t count on that, though. And, even if your employer did enroll you automatically, check it out and make sure your enrollment conforms to one or the other of the simple portfolios.
If your simple portfolio is in a Roth IRA you don’t have the option of contributing through payroll deductions. So, you have to create an effective substitute. The way to do that is:
A. Have your pay direct deposited to a checking account
B. Set up a weekly, monthly or twice monthly automatic transfer from the checking account to your Roth IRA cash account.
C. Set up a monthly purchase of your chosen simple portfolio investment(s) using the money in the Roth IRA Cash account.
Each investment option under the Roth IRA umbrella is assigned its own account number. Cash contributions will probably have to be initially received in a cash account or money market fund which will be one of the investment options under your Roth IRA umbrella.
Then, you will buy or exchange into the Target Year Mutual Fund (100%) or into the Equity Index (60%) and Bond Index (40%) Funds from the cash or money market account.
This is more complex to set up but your bank or Vanguard account representative will do the heavy lifting if you ask.
In either simple contribution scenario above, once you have the payroll deductions or account transfers set up, the whole thing will run on automatic pilot. Just read your monthly and quarterly statements to ensure everything is still running and to watch your balances grow.
Successful investing for your retirement can be simple.
The next post will explain simplicity in increasing annual contributions over time.
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
Friday, October 9, 2009
Structuring Your Simple Portfolio: Part 2 – Simplicity
Investing and personal finance is so complicated. There’s just too much to learn and know and research. I don’t have time for it. Besides, it’s boring!
I used to think that. I put off investing for retirement for years because of it. And after I started putting money in a 401k plan I borrowed from it and even took early withdrawals paying the income tax and the 10% penalty.
The amount of information and the risk can be overwhelming. But you don’t have to be a financial whiz kid to be successful. You can accumulate a sizable nest egg for a comfortable retirement with a very simple investing strategy. If you start young enough you can retire wealthy and retire early.
For the beginner, and for the uninterested, simplicity is the key to success.
1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio
1. Simplicity in Investment Portfolio
Absolutely the simplest investment portfolio is the Target Year Mutual Fund. This is a mutual fund managed with an objective of moderate growth and mitigating risk by asset allocation suitable to the time remaining before you retire. The fund manager does the asset allocation for you and as the years pass and the target year gets closer the manager reduces the percentage of the fund invested in stocks and increases the percentage in bonds.
Most 401k plans offer a selection of target date funds. Also Vanguard offers a series of target funds with target dates in five year increments starting with 2005 and ending with 2045. They are called “Vanguard Target Retirement 2045 Fund” with the actual target date substituted for “2045” for each fund.
The second simplest portfolio consists of two index mutual funds. Index funds are structured to closely match whatever index they are named for. The two funds in the second simplest portfolio are a total stock market index fund and a total bond market index fund. Vanguard offers both and they are highly regarded. Look for “Vanguard Total Stock Market Index Fund Investor Shares” and Vanguard Total Bond Market Index Fund Investor Shares”.
You will have you manage your asset allocations yourself and rebalance annually. But a simple asset allocation of this simple portfolio is 60% in the stock market index fund and 40% in the bond market index fund.
401k plans rarely offer index funds; if yours does use it, if not, substitute the offering closest to “large cap equity or stock fund” for the stock market index fund. And for the bond market index fund substitute the 401k offering closest to “bond fund or income fund”.
2. Simplicity in Account Types
The simplest account type for your simple portfolio is your employer’s 401k plan. If your employer has one, enroll in it. Many 401k plans, but not all, match a portion of your payday contributions. That’s free money, so if there’s a matching amount you should contribute at least enough to get your employer’s full match.
When you enroll in your 401k plan, select your simple portfolio using the guidelines described in section (1) above.
The second simplest account type is the Roth IRA. To set this up you must choose a brokerage or mutual fund company. For this purpose I recommend Vanguard.
When you set up your Vanguard Roth IRA you will also select the Vanguard mutual fund or funds for your simple portfolio using the guidelines described in section (1) above.
Investing for your retirement doesn’t have to be complicated – it can be simple.
The next post will explain simplicity in making account contributions and simplicity in increasing annual contributions over time
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
I used to think that. I put off investing for retirement for years because of it. And after I started putting money in a 401k plan I borrowed from it and even took early withdrawals paying the income tax and the 10% penalty.
The amount of information and the risk can be overwhelming. But you don’t have to be a financial whiz kid to be successful. You can accumulate a sizable nest egg for a comfortable retirement with a very simple investing strategy. If you start young enough you can retire wealthy and retire early.
For the beginner, and for the uninterested, simplicity is the key to success.
1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio
1. Simplicity in Investment Portfolio
Absolutely the simplest investment portfolio is the Target Year Mutual Fund. This is a mutual fund managed with an objective of moderate growth and mitigating risk by asset allocation suitable to the time remaining before you retire. The fund manager does the asset allocation for you and as the years pass and the target year gets closer the manager reduces the percentage of the fund invested in stocks and increases the percentage in bonds.
Most 401k plans offer a selection of target date funds. Also Vanguard offers a series of target funds with target dates in five year increments starting with 2005 and ending with 2045. They are called “Vanguard Target Retirement 2045 Fund” with the actual target date substituted for “2045” for each fund.
The second simplest portfolio consists of two index mutual funds. Index funds are structured to closely match whatever index they are named for. The two funds in the second simplest portfolio are a total stock market index fund and a total bond market index fund. Vanguard offers both and they are highly regarded. Look for “Vanguard Total Stock Market Index Fund Investor Shares” and Vanguard Total Bond Market Index Fund Investor Shares”.
You will have you manage your asset allocations yourself and rebalance annually. But a simple asset allocation of this simple portfolio is 60% in the stock market index fund and 40% in the bond market index fund.
401k plans rarely offer index funds; if yours does use it, if not, substitute the offering closest to “large cap equity or stock fund” for the stock market index fund. And for the bond market index fund substitute the 401k offering closest to “bond fund or income fund”.
2. Simplicity in Account Types
The simplest account type for your simple portfolio is your employer’s 401k plan. If your employer has one, enroll in it. Many 401k plans, but not all, match a portion of your payday contributions. That’s free money, so if there’s a matching amount you should contribute at least enough to get your employer’s full match.
When you enroll in your 401k plan, select your simple portfolio using the guidelines described in section (1) above.
The second simplest account type is the Roth IRA. To set this up you must choose a brokerage or mutual fund company. For this purpose I recommend Vanguard.
When you set up your Vanguard Roth IRA you will also select the Vanguard mutual fund or funds for your simple portfolio using the guidelines described in section (1) above.
Investing for your retirement doesn’t have to be complicated – it can be simple.
The next post will explain simplicity in making account contributions and simplicity in increasing annual contributions over time
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
Special Report: Structuring Your Simple Portfolio
Links to Topics in Special Report: Structuring Your Simple Portfolio
Structuring Your Simple Portfolio: Part 1 - Introduction
Structuring Your Simple Portfolio: Part 2 - Simplicity
Structuring Your Simple Portfolio: Part 3 - Simplicity in Contributions
Structuring Your Simple Portfolio: Part 4 - Simplicity in Increasing Contributions
Structuring Your Simple Portfolio: Part 5 - Simplicity in Rebalancing
Structuring Your Simple Portfolio: Part 1 - Introduction
Structuring Your Simple Portfolio: Part 2 - Simplicity
Structuring Your Simple Portfolio: Part 3 - Simplicity in Contributions
Structuring Your Simple Portfolio: Part 4 - Simplicity in Increasing Contributions
Structuring Your Simple Portfolio: Part 5 - Simplicity in Rebalancing
Friday, October 2, 2009
Structuring Your Simple Portfolio: Part 1 – Introduction
In the Asset Allocation series I advised choosing non-correlated investment classes for your portfolio; that is assets that don’t go up or down at the same time. I also recommended some specific asset classes. But you don’t invest in asset classes. You buy specific things. You buy shares in a mutual fund, common stock shares, bonds, gold coins, rental houses, government or corporate bonds. And, you buy them in specific types of investment accounts.
In this series, “Structuring Your Portfolio”, I will introduce various types of portfolios suitable for average people. From the very simplest portfolio structure to fairly sophisticated structures for people who enjoy the process of investing and want to make a hobby of it.
I can not make you a professional. I’m not a professional investor myself. Mostly, I’m a self-taught hobbyist amateur. Because I’m self-taught (lots of books, lots of free newsletters, and lots of trial and error) and a hobbyist, I think I can help you get started and help you improve your investing skills and your results.
Before deciding what to buy we should think about where our financial assets will reside. Even this bit can get complicated, but for most people the choices come down to these:
1. 401k (or equivalent) account administered by your employers
2. Traditional IRA accounts administered by a bank or brokerage company
3. Roth IRA accounts administered by a bank or brokerage company
4. Taxable accounts administered by a brokerage company
5. Bank accounts administered by a bank
6. Real assets administered by you
Each of these possible homes for your investments has certain advantages and disadvantages; characteristics largely created and defined by the federal government. The key features of each investment account type are described below. There are many minor features of each type that I’m not going to cover, so these descriptions are not comprehensive.
401k Accounts
401k plans are “tax deferred”. A percentage of your overall (before taxes) wages or salary is deducted from your pay every payday. You choose the percentage and you choose which of the limited number of investment options your payroll deduction buys.
Tax deferred means that you don’t pay income tax on the amount you contribute to the 401k account. You also don’t pay income taxes on any capital gains (increases in the value of the investments you bought) as long as the value stays in the 401k account.
In the end, you do pay income taxes on the money you withdraw from your 401k account – that’s the deferred part.
Traditional IRA Accounts
Traditional IRA’s are also tax deferred. Money you contribute up to the legal limit (currently $5,000) is tax deductable. Since your employer is uninvolved in your IRA the money is reported as income on your W-2 form, but you deduct it from your gross income when you file your income tax (Form 1040). If you withdraw money before you are 59 ½ years old you will be taxed at your normal rate plus 10% of the amount withdrawn early.
You neither report as earnings nor deduct the gains as long as the money remains in the IRA account. But, like the 401k, you pay income taxes on the money as it is withdrawn from the account. If you withdraw money before you are 59 ½ years old, the same 10% tax penalty applies as in the case of an early 401k withdrawal.
Roth IRA Accounts
Roth IRA’s are tax free instead of tax deferred. Contributions to your Roth cannot be deducted from your income tax for the year you made the contribution. But once money is in the account it will never again be subject to income tax even when it is withdrawn.
Taxable Accounts
Taxable accounts are not protected from income tax in any way. You may choose to purchase specific assets that have certain tax advantages, but the account itself conveys no tax advantage. They are typically not covered by any federal insurance program.
Bank Accounts
Like Taxable Accounts, Bank accounts have no tax advantages. They are protected from loss up to $250,000 per account by the Federal Deposit Insurance Corporation.
Real Assets
Real Assets are things like gold coins, $100 dollar bills, houses, or collectables. The only tax advantage is whatever break you get on your income tax rate for a capital gain as opposed to your rate for regular income. Rather than collecting interest or dividends on these assets you frequently must pay for insurance, storage, or maintenance.
Each of these investment account types could have a place in your portfolio of assets and you can use more than one or even all of them. It depends, as most thing do, on your inclinations, your desires, your expertise, your disposition, your age, your risk tolerance, and your financial net worth.
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
In this series, “Structuring Your Portfolio”, I will introduce various types of portfolios suitable for average people. From the very simplest portfolio structure to fairly sophisticated structures for people who enjoy the process of investing and want to make a hobby of it.
I can not make you a professional. I’m not a professional investor myself. Mostly, I’m a self-taught hobbyist amateur. Because I’m self-taught (lots of books, lots of free newsletters, and lots of trial and error) and a hobbyist, I think I can help you get started and help you improve your investing skills and your results.
Before deciding what to buy we should think about where our financial assets will reside. Even this bit can get complicated, but for most people the choices come down to these:
1. 401k (or equivalent) account administered by your employers
2. Traditional IRA accounts administered by a bank or brokerage company
3. Roth IRA accounts administered by a bank or brokerage company
4. Taxable accounts administered by a brokerage company
5. Bank accounts administered by a bank
6. Real assets administered by you
Each of these possible homes for your investments has certain advantages and disadvantages; characteristics largely created and defined by the federal government. The key features of each investment account type are described below. There are many minor features of each type that I’m not going to cover, so these descriptions are not comprehensive.
401k Accounts
401k plans are “tax deferred”. A percentage of your overall (before taxes) wages or salary is deducted from your pay every payday. You choose the percentage and you choose which of the limited number of investment options your payroll deduction buys.
Tax deferred means that you don’t pay income tax on the amount you contribute to the 401k account. You also don’t pay income taxes on any capital gains (increases in the value of the investments you bought) as long as the value stays in the 401k account.
In the end, you do pay income taxes on the money you withdraw from your 401k account – that’s the deferred part.
Traditional IRA Accounts
Traditional IRA’s are also tax deferred. Money you contribute up to the legal limit (currently $5,000) is tax deductable. Since your employer is uninvolved in your IRA the money is reported as income on your W-2 form, but you deduct it from your gross income when you file your income tax (Form 1040). If you withdraw money before you are 59 ½ years old you will be taxed at your normal rate plus 10% of the amount withdrawn early.
You neither report as earnings nor deduct the gains as long as the money remains in the IRA account. But, like the 401k, you pay income taxes on the money as it is withdrawn from the account. If you withdraw money before you are 59 ½ years old, the same 10% tax penalty applies as in the case of an early 401k withdrawal.
Roth IRA Accounts
Roth IRA’s are tax free instead of tax deferred. Contributions to your Roth cannot be deducted from your income tax for the year you made the contribution. But once money is in the account it will never again be subject to income tax even when it is withdrawn.
Taxable Accounts
Taxable accounts are not protected from income tax in any way. You may choose to purchase specific assets that have certain tax advantages, but the account itself conveys no tax advantage. They are typically not covered by any federal insurance program.
Bank Accounts
Like Taxable Accounts, Bank accounts have no tax advantages. They are protected from loss up to $250,000 per account by the Federal Deposit Insurance Corporation.
Real Assets
Real Assets are things like gold coins, $100 dollar bills, houses, or collectables. The only tax advantage is whatever break you get on your income tax rate for a capital gain as opposed to your rate for regular income. Rather than collecting interest or dividends on these assets you frequently must pay for insurance, storage, or maintenance.
Each of these investment account types could have a place in your portfolio of assets and you can use more than one or even all of them. It depends, as most thing do, on your inclinations, your desires, your expertise, your disposition, your age, your risk tolerance, and your financial net worth.
Link to Other Topics in the Special Report: Structuring Your Simple Portfolio
Friday, September 25, 2009
Asset Allocation: Part 4 – Risk Tolerance
In Part 2 of this asset allocation series I assumed 25% allocations for each asset class in the example portfolio. Selecting the target asset allocations for your portfolio is not a science – despite the “Risk Tolerance” surveys and formulae offered by many financial planners.
There are some basic concepts you should consider when setting asset allocations:
1. The closer you are to retiring the greater the allocation of your total assets to “safer” asset classes and the lower your allocation to “risky/aggressive” asset classes.
2. Money you expect to need within the next five to ten years (depending on which financial planner you listen to) should be held in cash or cash equivalents; money market funds, Bank CD’s (certificates of deposit), or laddered bonds (not bond funds).
3. A large enough allocation must be made to more aggressive asset classes to keep up with inflation because the average woman who retires at the age of 62 will live another 25 years; the average man another 20. Many will live 30 years after retiring and some will live 40. In 30 years even moderate inflation rates can be devastating to the value of your portfolio.
4. Emergency funds must be held in cash or cash equivalents that can be withdrawn quickly without penalties.
5. If allocations are too lopsided in favor of any asset class rebalancing will have little value.
6. You have to sleep at night. If your investments keep you from sleeping change your allocations to favor safer asset classes.
Planners advocate allocation plans that vary all over the place. I’ve read advice for twenty-somethings to be 100% in growth stocks. At the other extreme, I’ve seen advice that everyone, regardless of age, should be 50% in stocks and 50% in bonds.
Here’s my advice:
1. Have some money in cash, have some money in bonds, have some in stocks, have some in gold, and have some in real estate. Each of these asset classes should be at least 10% of your portfolio value and none should exceed 70%.
2. Your emergency fund is not part of your portfolio. It should be 100% cash and not count as the cash portion of your portfolio.
3. If you are within five years of retiring you should start building up the cash portion of your portfolio so that on the day you retire you will have enough cash in your portfolio to cover your expenses for five years – after subtracting expenses you plan to pay with money from Social Security, a fixed pension, or income from an annuity.
4. Within these constraints, design your portfolio to grow to meet or beat inflation not counting the new money you will invest – but with asset allocations that let you sleep at night.
5. Rebalance your portfolio annually – perhaps around your birthday.
6. Reconsider your asset allocations annually. You’re getting older and you may be getting wiser.
Risk tolerance and setting asset allocations is more art than science regardless of the research and the formulae used by financial planners.
Links to other Topics in the Special Report: Asset Allocation
There are some basic concepts you should consider when setting asset allocations:
1. The closer you are to retiring the greater the allocation of your total assets to “safer” asset classes and the lower your allocation to “risky/aggressive” asset classes.
2. Money you expect to need within the next five to ten years (depending on which financial planner you listen to) should be held in cash or cash equivalents; money market funds, Bank CD’s (certificates of deposit), or laddered bonds (not bond funds).
3. A large enough allocation must be made to more aggressive asset classes to keep up with inflation because the average woman who retires at the age of 62 will live another 25 years; the average man another 20. Many will live 30 years after retiring and some will live 40. In 30 years even moderate inflation rates can be devastating to the value of your portfolio.
4. Emergency funds must be held in cash or cash equivalents that can be withdrawn quickly without penalties.
5. If allocations are too lopsided in favor of any asset class rebalancing will have little value.
6. You have to sleep at night. If your investments keep you from sleeping change your allocations to favor safer asset classes.
Planners advocate allocation plans that vary all over the place. I’ve read advice for twenty-somethings to be 100% in growth stocks. At the other extreme, I’ve seen advice that everyone, regardless of age, should be 50% in stocks and 50% in bonds.
Here’s my advice:
1. Have some money in cash, have some money in bonds, have some in stocks, have some in gold, and have some in real estate. Each of these asset classes should be at least 10% of your portfolio value and none should exceed 70%.
2. Your emergency fund is not part of your portfolio. It should be 100% cash and not count as the cash portion of your portfolio.
3. If you are within five years of retiring you should start building up the cash portion of your portfolio so that on the day you retire you will have enough cash in your portfolio to cover your expenses for five years – after subtracting expenses you plan to pay with money from Social Security, a fixed pension, or income from an annuity.
4. Within these constraints, design your portfolio to grow to meet or beat inflation not counting the new money you will invest – but with asset allocations that let you sleep at night.
5. Rebalance your portfolio annually – perhaps around your birthday.
6. Reconsider your asset allocations annually. You’re getting older and you may be getting wiser.
Risk tolerance and setting asset allocations is more art than science regardless of the research and the formulae used by financial planners.
Links to other Topics in the Special Report: Asset Allocation
Friday, September 18, 2009
Asset Allocation: Part 3 - Rebalancing
Having a mix of uncorrelated asset classes in your portfolio tends to protect the portfolio from downturns and to limit the gain from upturns in any asset class. Asset rebalancing is a powerful tool to improve your overall results.
Most financial planners recommend rebalancing annually. Others have data showing portfolio gains are higher when it is done less frequently – every two or three years. Yet another recommendation I’ve seen is to set gain or loss targets and rebalance only when one of the targets is attained.
Whatever rebalancing frequency is used, the act of rebalancing is the same. You choose an allocation percentage in advance for each asset class and, when you rebalance, you sell enough of the class that is above target to bring its actual portfolio percentage back to its target.
On the other side of the transaction, you buy enough of the classes that are below target to bring their portfolio percentages back up to target. For a portfolio in which you’re still investing new money, you can rebalance by buying only the asset classes that are below target.
When you periodically rebalance, you systematically sell investments that are up in value while their prices are high; and you systematically buy more of the classes that have declined in value while their prices are low.
The old truism is that the essence of investing is to buy low and sell high. Unfortunately, most people don’t have the self-discipline to execute that advice. Plus, nobody knows when the price has stopped going up until it goes back down. Nor do they know when the price is hits bottom until it goes back up. Consequently, most people invest by emotion and often buy high and sell low.
Asset rebalancing makes the “buy low, sell high” discipline much easier to live; you just move the money from one asset class already in your portfolio to others using pre-set rules for the transaction timing and amounts.
I’ve seen data that indicate regular rebalancing over many years increases the final portfolio value by 30% to 100%.
Asset rebalancing improves your investing results in a portfolio of uncorrelated asset classes.
Links to other Topics in the Special Report: Asset Allocation
Most financial planners recommend rebalancing annually. Others have data showing portfolio gains are higher when it is done less frequently – every two or three years. Yet another recommendation I’ve seen is to set gain or loss targets and rebalance only when one of the targets is attained.
Whatever rebalancing frequency is used, the act of rebalancing is the same. You choose an allocation percentage in advance for each asset class and, when you rebalance, you sell enough of the class that is above target to bring its actual portfolio percentage back to its target.
On the other side of the transaction, you buy enough of the classes that are below target to bring their portfolio percentages back up to target. For a portfolio in which you’re still investing new money, you can rebalance by buying only the asset classes that are below target.
When you periodically rebalance, you systematically sell investments that are up in value while their prices are high; and you systematically buy more of the classes that have declined in value while their prices are low.
The old truism is that the essence of investing is to buy low and sell high. Unfortunately, most people don’t have the self-discipline to execute that advice. Plus, nobody knows when the price has stopped going up until it goes back down. Nor do they know when the price is hits bottom until it goes back up. Consequently, most people invest by emotion and often buy high and sell low.
Asset rebalancing makes the “buy low, sell high” discipline much easier to live; you just move the money from one asset class already in your portfolio to others using pre-set rules for the transaction timing and amounts.
I’ve seen data that indicate regular rebalancing over many years increases the final portfolio value by 30% to 100%.
Asset rebalancing improves your investing results in a portfolio of uncorrelated asset classes.
Links to other Topics in the Special Report: Asset Allocation
Friday, September 11, 2009
Asset Allocation: Part 2 – Asset Classes
Asset Allocation is kind of like putting your eggs in several baskets and giving the baskets to people who take different routes to Granny’s house. The trick is to choose high quality baskets and to choose routes so the Wolf can’t intercept more than one basket.
The value of your investment portfolio should be divided among several different asset classes. Examples of asset classes are cash (bank or money market accounts), U.S common stocks, U.S. preferred stocks, U.S. corporate bonds, U.S. government bonds, commodities, international stocks, international bonds, and real estate. This is an incomplete list but covers the classes most commonly considered and bought.
Asset class subcategories include large cap stocks (big public companies), small cap stocks (relatively small public companies), growth company stocks, value stocks, and dividend paying stocks. Subcategories frequently overlap with a single company falling into more than one category.
Asset allocation is not just diversification. Diversification refers to owning multiple stocks or bonds with the objective being to protect your wealth in the event one of the companies you are invested in becomes worthless. To be sure, asset allocation also provides the protection of diversification. The difference is that in asset allocation you intentionally invest in asset classes that tend to increase or decrease in value independently from one another.
For example, usually as the price of stocks go up the price of bonds go down. The same is true of cash and commodities – when one goes up the other normally goes down.
Nowadays, there are ways to invest in commodities and real estate through stocks, ETF’s and mutual funds so even a modest portfolio, like mine, can take advantage of asset allocation using a variety of asset classes. A sample portfolio might consist of shares in an Extended Market Mutual Fund, a Total Market Bond Fund, a REIT (Real Estate Investment Trust) Fund, and a Precious Metals Mutual Fund. The allocation percentages might be set to 25% for each class.
The sample portfolio might behave in the following ways under the specified market conditions:
1. Conditions - slow economic growth with low inflation:
a. Extended Market Mutual Fund increases slowly
b. Total Market Bond Fund is stable and paying consistent dividends
c. REIT Funds increase slowly
d. Precious Metals Mutual Fund declines slowly
2. Conditions – slow economic growth with high inflation:
a. Extended Market Mutual Fund is stable
b. Total Market Bond Fund declines
c. REIT Funds increases rapidly
d. Precious Metals Mutual Fund increases rapidly
3. Conditions – recession with low inflation
a. Extended Market Mutual Fund declines
b. Total Market Bond Fund increases
c. REIT Funds decline
d. Precious Metals Mutual Fund is stable
Ideally, one or more asset classes will go up regardless of the market conditions. By itself, this kind of an asset mix will tend to preserve the value of the portfolio protecting it from big declines and also preventing big increases. A powerful tool to improve this result is “rebalancing”.
The next post will explain portfolio rebalancing.
Links to other Topics in the Special Report: Asset Allocation
The value of your investment portfolio should be divided among several different asset classes. Examples of asset classes are cash (bank or money market accounts), U.S common stocks, U.S. preferred stocks, U.S. corporate bonds, U.S. government bonds, commodities, international stocks, international bonds, and real estate. This is an incomplete list but covers the classes most commonly considered and bought.
Asset class subcategories include large cap stocks (big public companies), small cap stocks (relatively small public companies), growth company stocks, value stocks, and dividend paying stocks. Subcategories frequently overlap with a single company falling into more than one category.
Asset allocation is not just diversification. Diversification refers to owning multiple stocks or bonds with the objective being to protect your wealth in the event one of the companies you are invested in becomes worthless. To be sure, asset allocation also provides the protection of diversification. The difference is that in asset allocation you intentionally invest in asset classes that tend to increase or decrease in value independently from one another.
For example, usually as the price of stocks go up the price of bonds go down. The same is true of cash and commodities – when one goes up the other normally goes down.
Nowadays, there are ways to invest in commodities and real estate through stocks, ETF’s and mutual funds so even a modest portfolio, like mine, can take advantage of asset allocation using a variety of asset classes. A sample portfolio might consist of shares in an Extended Market Mutual Fund, a Total Market Bond Fund, a REIT (Real Estate Investment Trust) Fund, and a Precious Metals Mutual Fund. The allocation percentages might be set to 25% for each class.
The sample portfolio might behave in the following ways under the specified market conditions:
1. Conditions - slow economic growth with low inflation:
a. Extended Market Mutual Fund increases slowly
b. Total Market Bond Fund is stable and paying consistent dividends
c. REIT Funds increase slowly
d. Precious Metals Mutual Fund declines slowly
2. Conditions – slow economic growth with high inflation:
a. Extended Market Mutual Fund is stable
b. Total Market Bond Fund declines
c. REIT Funds increases rapidly
d. Precious Metals Mutual Fund increases rapidly
3. Conditions – recession with low inflation
a. Extended Market Mutual Fund declines
b. Total Market Bond Fund increases
c. REIT Funds decline
d. Precious Metals Mutual Fund is stable
Ideally, one or more asset classes will go up regardless of the market conditions. By itself, this kind of an asset mix will tend to preserve the value of the portfolio protecting it from big declines and also preventing big increases. A powerful tool to improve this result is “rebalancing”.
The next post will explain portfolio rebalancing.
Links to other Topics in the Special Report: Asset Allocation
Friday, September 4, 2009
Asset Allocation: Part 1 - Introduction
Financial Planners seem to talk about asset allocation all the time. They recommend percentage allocations to various investments (usually different mutual funds) based on some assessment of your “risk tolerance”.
Usually you end up buying some shares in a “large cap growth” fund, a “large cap value” fund, a “small cap” fund, an “international” fund, and a “bond” fund. The percentages vary with your age and your “risk tolerance”.
Asset Allocation is kind of like parceling your eggs out into three to six different baskets, giving each basket to a different person and instructing each person to take a different route to Granny’s house. Most of the baskets will get to Granny and miraculously, each basket that arrives at Granny’s house will have more eggs at the end than it had at the beginning of the trip.
Like most people, my first exposure to asset allocation was sitting down with a Financial Planner who was armed with a “Risk Tolerance Assessment Survey” and a “Financial Goals Survey”. I filled out the surveys and several days later a “Personalized Financial Plan” was delivered to my doorstep filled with monthly saving and investing targets, asset allocation percentages for each of the recommended mutual funds, and of course, Life Insurance.
It was a decent plan and I promptly filed it away where it would not likely see daylight again for several years. My budget couldn’t be squeezed enough to do half of the Personalized Financial Plan and the guy was obviously trying to sell life insurance so I did nothing. That was a mistake.
If I had done even a little of the investing portion of the plan I would be much wealthier today - some thirty years later. But I was young, foolish, over-confident, indestructible, ambitious, and over-whelmed by the whole “asset allocation” thing – plus suffering from sticker shock.
I can’t help you with the young, foolish, over-confident, indestructible, and ambitious parts. But I can help with the “over-whelmed” part and the sticker shock part.
The Asset Allocation trick is to choose high quality baskets and to select the various routes to Granny’s house so the Wolf can’t intercept more than one of them.
In Part 2, I’ll discuss selecting the routes – that is – selecting different types of investments that are poorly or even negatively correlated.
Links to other Topics in the Special Report: Asset Allocation
Usually you end up buying some shares in a “large cap growth” fund, a “large cap value” fund, a “small cap” fund, an “international” fund, and a “bond” fund. The percentages vary with your age and your “risk tolerance”.
Asset Allocation is kind of like parceling your eggs out into three to six different baskets, giving each basket to a different person and instructing each person to take a different route to Granny’s house. Most of the baskets will get to Granny and miraculously, each basket that arrives at Granny’s house will have more eggs at the end than it had at the beginning of the trip.
Like most people, my first exposure to asset allocation was sitting down with a Financial Planner who was armed with a “Risk Tolerance Assessment Survey” and a “Financial Goals Survey”. I filled out the surveys and several days later a “Personalized Financial Plan” was delivered to my doorstep filled with monthly saving and investing targets, asset allocation percentages for each of the recommended mutual funds, and of course, Life Insurance.
It was a decent plan and I promptly filed it away where it would not likely see daylight again for several years. My budget couldn’t be squeezed enough to do half of the Personalized Financial Plan and the guy was obviously trying to sell life insurance so I did nothing. That was a mistake.
If I had done even a little of the investing portion of the plan I would be much wealthier today - some thirty years later. But I was young, foolish, over-confident, indestructible, ambitious, and over-whelmed by the whole “asset allocation” thing – plus suffering from sticker shock.
I can’t help you with the young, foolish, over-confident, indestructible, and ambitious parts. But I can help with the “over-whelmed” part and the sticker shock part.
The Asset Allocation trick is to choose high quality baskets and to select the various routes to Granny’s house so the Wolf can’t intercept more than one of them.
In Part 2, I’ll discuss selecting the routes – that is – selecting different types of investments that are poorly or even negatively correlated.
Links to other Topics in the Special Report: Asset Allocation
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