Wednesday, October 29, 2008

Now is a Good Time to Review Allocation Strategies

"Don't mistake a bull market for brains." ~ stock market expression.

During good economic times, investors often feel smart, look smart and become wealthier. It appears everyone and every investment is making money. Getting richer seems guaranteed.

Unfortunately, bear markets do occur. In my experience, market declines will stress test one's investment strategies. In reviewing our strategies, I found that the allocation of investments by time and risk were the most helpful factors for weathering this bear market.
  1. Allocation by when the funds are needed. A principle that worked for us is to keep money we really need (e.g. short term expenses) in investments that are liquid and don't fluctuate. For example, next year's college tuition, a house down payment, or 2-5 years retirement living expenses would be kept in money market funds or bank CDs.

    In a bull market, such as strategy appears overly risk averse, since the returns are much lower. We consider lower returns a reasonable trade off for a guarantee of the amount that will be available.

    For funds that are not needed for at least 5 years, we will invest in the stock market or real estate. It is important to periodically sell some long term funds, hopefully when the market is up, to replenish the amount in the short term liquid investments that are being spent.

  2. Allocation by risk. In Risk Allocation in a Wealth Portfolio, I wrote about how investment risk should be divided among Personal (lowest) Risk, Market (medium) Risk, and Aspirational (highest) Risk. To me, the key is to have the investments in the personal risk allocation (e.g CDs, cash, home) account for about 40% of total savings. Doing so provides a good buffer when the market declines.

    At the end of September, 2008, the allocation in the personal risk area was at 34%. Currently, the allocation in the personal risk area is 37%, due primarily to the decline of the stock market in October, 2008.

While the declines in the stock market have significantly reduced our stock portfolio, having higher allocations in low risk/stable investments has helped us preserve savings that is needed in the near term. For us, giving up higher returns in a bull market has been worth the increased preservation of savings during this bear market.

For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC

1 comment:

Jesse W. said...

Reallocating assets is something that should be done with discipline no matter how much money is made or lost; it is just hard to do it when the psychology is to always put money in investment vehicles that are doing well.

Jesse W.