Your investment portfolio must reflect what your money needs to do for you. If it doesn’t, you may be taking too much risk with your investments or, on the other hand, you may be missing out on important growth. Either way, you and your family are the losers. Make sure your investment portfolio doesn’t reflect a "one size fits all" mentality.
Asset allocation is the most important aspect of your investment strategy. It dictates the amount of dollars invested in cash, stock, bonds, real estate, or other types of investment vehicles. Your personal situation, and not that of your neighbor, determines your asset allocation. The way your money is invested should be customized for you and based on your needs.
Asset Allocation Rules
Rule #1: Do not invest in the stock market unless you anticipate leaving the funds invested for at least five years, preferably longer.
The stock market will go up and down. This is a "fact," not a hypothesis. The history of the market shows us that money invested for a least a five-year period has a high probability of reflecting an increased value at the end of the period relative to the beginning. For a ten-year period, the probability of a gain is even greater. There are no guarantees, but investors who have the ability to stay invested over a long period of time have been rewarded for their patience.
Rule #2: Funds that you need within a five-year period should be invested in the fixed income arena.
With today’s low interest rates, it is difficult to think about investing in fixed income. However, that is exactly what you need to do if funds from your investment portfolio are needed to pay next year’s college tuition or replace an auto in three years. Those dollars should be invested in vehicles that are expected to maintain a stable value even if the investment return is less than you would like.
Dollars needed in the next five years should not be subject to the risk of the stock market. Savings accounts, money market funds, and certificates of deposit are the most stable investments. Corporate bonds and government bonds such as Treasury bills will remain fairly constant, but can have some fluctuation in value when interest rates or economic conditions change.
Determine the Appropriate Asset Allocation for You
The appropriate asset allocation will protect you in a down-market and assist you in an up-market. The asset allocation used in your portfolio must be based on your particular situation and not that of a co-worker or relative. The allocation must reflect your anticipated use of the funds.
Situation: Married with two children
If you are age 35 and married with two children, ages 8 and 10, you need to save for college education, your retirement, and perhaps an addition to the house. Your 401(k) or IRA funds can be invested in the stock market since it is likely that you will not need these funds for at least twenty years or longer. The college funds can be invested in the stock market until the children reach high school, then you will want to consider a change in the allocation to invest those dollars needed in a fixed income vehicle. The money you are saving for the house addition next year must definitely be in fixed income assets only. There is nothing more disappointing than to postpone a project because the stock market went down!
Situation: Retired married couple
If you and your spouse are age 65, your portfolio will likely be very different from the 35-year-old couple discussed above. If you plan to withdraw $30,000 per year from your investment portfolio to supplement your pension and social security, you should have at least $150,000 (five years of distribution needs) invested in fixed income. Depending on the size of your portfolio and your overall financial situation, you may want a greater amount in fixed income to provide more stability in your portfolio.
Change your Asset Allocation with your Situation
As you move through stages of your life, your asset allocation needs to be revised to reflect your needs. Today’s asset allocation should be based on your need for funds over the next five to ten years. As your future needs change, your asset allocation needs to be adjusted. "Single" with no family responsibilities to "married with children" requires a change in your asset allocation. Likewise, making a decision to retire in five years versus ten years requires a close review of your total investment portfolio.
Don’t get caught thinking you should invest your funds in the same manner as your neighbor. To successfully meet your financial goals, your asset allocation must reflect your unique needs. Think it through yourself or work with your financial planner or investment advisor to assure the most important aspect of your investment portfolio is appropriate for you.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money" segment. Elaine’s book, "Advice You Never Asked For… But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at firstname.lastname@example.org.