In 1970, The Temptations released a song under the Motown label called “Ball of confusion”. Read the lyrics and it could be written for today. An ongoing global pandemic, some states reversing opening, unprecedented federal and fiscal intervention, unemployment at 13%, social unrest & demonstrations, calls for significant societal changes, presidential campaigns heating up, social distancing, “and the band played on”.
During such a time, it can be confusing on what to do from an investing standpoint, and there is no shortage of pundits telling you what to do. “Cash everything in”, “buy on the dips”, “factor investing”, “buy tech”, “buy pharma”, bet on the Fed and buy everything…. On and on.
If I had told you that from May 27th to June 27th, the market (using the S&P 500 as “the market”) would drop less than 1%, chances are you might have said “that’s not too bad” considering the almost unprecedented wide range of events going on. If I had told you that the S&P 500 today was off almost 10% from the February 19, 2020 high of 3,386, you might feel different. But if I told you that the over the last five years, (through 6/30/20), the market was up 48%, you might feel different…. Again.
Asset allocation is a simple concept… don’t put all your eggs in one basket or as the Bible says in Ecclesiastes 11:2 “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land”.
Asset allocation is about three things 1.) Diversification, across several sectors so that when one or more go down (or up) the others balance your portfolio; 2.) Risk tolerance, how much risk are you comfortable taking; and 3.) Timeframe you are investing for, someone in their 20’s or 30’s should have a different asset allocation than someone closer to retirement.
Before I continue, I would emphasize that investing comes after you have set aside at least 3-6 months of expenses, paid off your debts (your mortgage being the exception) and saved for near term cash needs such as a car, tuition, buying a home etc….
The most basic asset allocation is between stocks and bonds. The younger you are, the more it is recommended to put into stocks and reduce the stock portion as you get older. A typical portfolio for a twenty-something might be 70-90% stocks and the rest in bonds. For a person in their 50’s or nearing retirement, their asset allocation might be closer to a 50/50 mix.
The roller coaster ride the markets have been under can be very disconcerting but investing is not for the short term. You should invest with a 10+ year timeframe. That’s why it is very important to have set aside your reserves because the last thing you want is to be forced to sell investments when the markets are down because you need cash.
Utilizing research from Vanguard, the following mix of portfolios show expected annual returns over the long term (1926-2019).
70% stocks/30% bonds = 9.2% annual return
50% stocks/50% bonds = 8.3%
30% stocks/70% bonds = 7.2%
As you can see, the expected returns go down as the portion of bonds in the portfolio are increased. However, any significant drop in the market will be less volatile with a larger bond position. A younger person will have more time to make up any market corrections but an older person will not have as much time before needing the money, thus protecting against the downside becomes more important.
Successful investing is about having patience, saving money consistently, and looking at the long term. Investing is not for the “make me rich quick” mindset. Proverbs 13:6 says “A wise man thinks ahead; a fool doesn’t, and even brags about it”.
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