"Money often costs too much." -- Ralph Waldo Emerson (1803-1882)
Considering the market volatility during the year, specifically the Asian market-triggered meltdown of February 27 up to the string of records on the Dow since then, a post on asset allocation is as timely as ever. Clients, friends, family, neighbors, and Blog readers alike keep asking me similar questions: "How far will the market go this year?" "Should I buy, hold, or sell in this market?" "Are stocks due for a correction?" "Is the U.S. economy headed for recession in 2007?" Depending on who I am speaking with my response is worded differently but it essentially says, "Who cares?" Unless you are a professional market timer (which, if you think about it, is an oxymoron) you should be using stocks for their most logical purpose (long-term investing) and your investment portfolio should be allocated in such a way that allows you to respond similarly when someone comments on the market news of the day: "Who cares?"
Simply stated, one can not logically begin the asset allocation process by constructing a portfolio based upon unknown variables; therefore, we must begin the process of asset allocation by separating the known from the unknown. The investor's (1) Investment Objective, (2) Investment Time Horizon, (3) Amount of Money available to Invest, and (4) Risk Tolerance/Capacity are, in my opinion, the only known variables while everything else, such as future market performance, is largely unknown. Asset allocation is about creating and maintaining a portfolio of assets (stocks, bonds, cash) that is based upon those four known variables so the investor's concern over the unknown variables are significantly reduced or even removed. Furthermore, proper asset allocation effectively reduces volatility, which, in turn, reduces the human temptation to buy or sell into short-term market movements. As a caveat, those four known variables, especially numbers three and four, may be difficult to quantify or qualify without proper planning, which I'll assume my readers have already done.
Before tackling a model portfolio, let's review our logical findings from previous "Invest Like a Philosopher" posts:
- A philosopher is highly aware of his or her own ignorance; therefore, unless the investor is knowledgeable and passionate about investing, they would leverage the wisdom of others to manage their assets. That way, time is freed to spend on things of higher importance to the individual -- those things with high intrinsic value -- your true passions. Consider this: Would you hire yourself or even recommend yourself to others as an investment advisor?
- One may best leverage the wisdom of others by either hiring a "fee only" financial planner with in-depth knowledge of investments to manage their assets or by managing their own assets and leveraging the knowledge of others through prudent mutual fund selection.
- Mutual funds are preferable to individual securities because the amount of time necessary to properly research securities, such as stocks, rarely provides a long-term return to the individual that is greater than the market averages.
- "Passively Managed" funds, such as Index Funds or Exchange Traded Funds (ETFs) are preferred to actively managed funds in the area of large capitalization stocks. This is due to the Efficient Market Hypothesis (EMH).
In summary, time is money. Money "costs too much" when avoidable mistakes are made and our valuable time is "spent" on trivial pursuits. Asset allocation is done properly when short-term market movements and "media noise" are not a concern to the investor and the unnecessary complexities of investment research, analysis, selection, and monitoring are reduced (or even removed) to the degree that the individual investor may spend their valuable time in pursuit of their true passions...
Now we are ready for asset allocation! In the interest of making this information more digestible, I'll deliver model portfolios in separate blog posts. Stay tuned...
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and comprehensive financial planning.
Comments