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Sunday, December 31, 2017

Alpha Teach Yourself Investing in 24 Hours: An Analysis (part 48)




Working Toward a Goal:
Asset Allocation
by
Charles Lamson


Portfolio Components

Asset allocation is about spreading risk over different asset classes to even out the peaks and valleys. Most financial professionals feel that your portfolio should consist of a mix of bonds and stocks. Some would add cash to the mix but most would not.

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The obvious questions here are
  • Which stocks in what portion?
  • Which bonds in what portion?
The answer, like most answers to investing questions, is: "It depends." It depends on your age and risk tolerance. A young, aggressive investor will look at these questions quite differently than a middle-aged conservative investor.

It might be helpful to look at the problem from an age/risk perspective. Again, we are assuming that the investment goal is funding retirement by age 65.

JUST A MINUTE
The suggested allocations do not include a cash component. Many financial professionals do include cash. This is a personal preference. Do what is most comfortable for you.

We will look at age groups starting with the youngest and working forward. Each age group will have three levels of risk tolerance: conservative, moderate, and aggressive with suggestions for each. There is no official asset allocation formula, so consider these suggestions as just that: a starting point for your own thinking.

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Age 20-30

It may be hard to think seriously about retirement at this age, but you could not pick a better time to start. Not only will you almost certainly build a substantial nest egg, but you will get in the habit of investing that will serve you well the rest of your life.


Conservative Portfolio

A conservative approach at this age suggests a stock/bond mix for long-term growth and stability. An additional consideration is that there will not be a lot of money invested in this period, so mutual funds make more sense than individual issues.

Stocks
S&P 500
index
fund
80 percent
Bonds
Long-term
bond index
fund
20 percent

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Moderate Portfolio

A more aggressive approach might stay with a stock/bond mix, but change the portions somewhat.

Stocks
Large-cap value fund
25 percent

Large-cap growth fund
50 percent

Foreign stocks fund
15 percent
Bonds
Long-term bond index fund
10 percent


Aggressive Portfolio

Our young lion wants to roar; so we drop bonds from the mix completely.

Stocks
Small-cap growth fund
40 percent

Small-cap value fund
30 percent

Foreign stocks fund
30 percent


Age 30-40

For many of us this is the age in which we begin to settle down and start thinking about our future. Retirement is still a long way off but not so far that it is off our radar screen altogether.

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Conservative Portfolio

Our conservative investor can stand put or if she believes the stock market is looking shakey, move more assets into long-term bonds.

Stocks
S&P 500 index fund
70 percent
Bonds
Long-term bond index fund
30 percent


Moderate Portfolio

Our moderate friend is happy with the mix, but just to be on the safe side, ups the percentage of bonds.

Stocks
Large-cap value fund
25 percent

Large-cap growth fund
40 percent

Foreign stocks fund
15 percent
Bonds
Long-term bond index fund
20 percent


Aggressive Portfolio

Our young lion still wants to roar but begins to understand the danger of staying heavily invested in one area (small-cap stocks).

Stocks
Small-cap growth fund
40 percent

Large-cap growth fund
40 percent

Foreign stocks fund
20 percent


Age 40-50

As we enter the years of our peak earning capacity, retirement begins to seem like a not-to-distant hill looming larger and larger.


Conservative Portfolio

Our conservative investor hears retirement calling more loudly than most. She grows more nervous about stocks and moves more assets into long-term bonds.

Stocks
S&P 500 index fund
60 percent
Bonds
Long-term bond index fund
40 percent


Moderate Portfolio

Our moderate friend is becoming nervous about the stock/bond ratio and moves to up the bond component at the expense of the large-cap growth fund.


Stocks
Large-cap value fund
25 percent

Large-cap growth fund
30 percent

Foreign stocks fund
15 percent
Bonds
Long-term bond index fund
30 percent


Aggressive Portfolio

Our young lion realizes he is not a young lion anymore, but wants to stay heavily invested in stocks as is prudent. His move into bonds discards the fund notion and buys bonds directly for a better yield even though the risk is higher.

Stocks
Small-cap growth fund
20 percent

Large-cap growth fund
40 percent

Foreign stocks fund
20 percent
Bonds
Long-term bond index fund
20 percent


Age 50-60

These are the years we set the stage for requirement, getting our ducks in a row and guarding against any fourth quarter surprises by the market.


Conservative Portfolio

Our conservative investor is focusing on calculating what her living expenses will be and how much she will have coming in between Social Security and her retirement. The focus is shifting to income and capital preservation. She will stay in equities but will move out of an index fund and into solid income stocks like utilities. At the same time, she will slowly shift out of a bond fund and into individual bonds (10 years or more) that begin maturing at retirement. At the end of this period, her portfolio looks like this:

Stocks
High-quality income stocks
50 percent
Bonds
Long-term bonds
50 percent


Moderate Portfolio

Our moderate friend also begins moving toward income and away from growth, but not completely. Foreign stocks look too unstable, so they get dropped. He also begins shifting away from a bond index fund and into high-quality individual bonds.

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Stocks
Large-cap value fund
40 percent

Large-cap growth fund
20 percent
Bonds
Long-term bonds
40 percent


Age 60-??

Even though we may not retire until 65 (and many people are continuing to work after 65), we are in a retirement mode at this point with our investments.


Conservative Portfolio

Our conservative investor continues her shift to current income and capital preservation. However, she is aware that being too conservative may cause her to outlive her money.

Stocks
High quality income stocks
30 percent
Bonds
Long-term bonds
40 percent

Bond index fund
30 percent
  

Moderate Portfolio

Our moderate friend begins the shift to a heavier emphasis on income and away from growth.

Stocks
Large-cap value fund
20 percent

High-quality income stocks
40 percent
Bonds
Long-term bonds
40 percent


Aggressive Portfolio

Our now not-so-agile young lion finds golf more interesting than investing but still keeps his toe in the water.

Stocks
Large-cap value fund
30 percent
Bonds
Long term bonds
70 percent

*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 292-297*

END

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