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Securing Your Future With Asset Allocation.
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By:
Steven Samblis
Let me ask you a
question. What is the hardest part about investing in the stock market? I ask
this question at the beginning of my seminars and I hear the same thing over and
over again. It's not picking the right stocks or the right broker. The hardest
part about investing in the stock market is just getting started. Lets face it,
you can go out and get a plethora of magazines and newspapers that talk about
where the market is now, but nobody explains the steps to get started. No one
says to you, "here is step A, B, C, etc". What I would like to do for you today
is give you the steps to get started in the right direction. Even if you are
currently invested in the stock market and doing OK, following these steps will
make you a more successful investor. It's never too late to begin investing the
right way.
The first thing you need to do when investing in the stock market is to
determine your time. In other words, make a determination of how much time you
have for your pool of assets. What does this mean? If you determine you have
five years for your portfolio, that you need your money back in five years,
studies say you should have 50% of your money in stocks and 50% in bonds. If you
feel that you have five to ten years then the studies say you should have 75% of
your money in stocks and 25% in bonds. If you decide that you have more than ten
years, studies show the best asset allocation is 80% of your money in stocks and
the balance in bonds.
You may ask, why does the time parameters make a determination on my asset
allocation. The answer to the question is simple. Look at the market since
inception, when people talked with telegraphs instead of telephones. There has
never been a ten- year period in the market that stocks did not show a positive
return. If you say to me that you have ten or more years to invest, are the odds
with you? Of course they are. If you have five or less years the odds aren't as
much in your favor.
Why not put all my money in the stock market? That's where the big money is
being made. On the surface this may seem the right path, but it is way off.
Stocks are an asset class. Bonds are an asset class. Cash is an asset class.
Having only one asset class in a portfolio is always more risky then two. Two
asset classes diversify your risk. If the second asset class is a higher
returning asset class, you not only reduce your risk, but also increase you
returns. This means, if you have a 100% bond portfolio and change it to 90%
bonds 10% stocks, you will reduce your risk and increase the portfolios total
return. Yes! Less risk more return!
For the purpose of this column I will use the example of an individual that says
he has five to ten years before he needs to touch his money. With this person we
have 75% of the portfolio in stocks and 25% in bonds.
Let me make a quick point. When stocks are going up in value, bonds are usually
falling in value. The inverse is also true. When the stock market is falling,
bonds increase in value. The reason for this is what some call "the flight to
quality". This is especially clear to see during large market drops. When stocks
are really falling out of bed, bonds are going up in value. This is because the
institutions that make up most of the market have to put their money somewhere.
When they sell stocks they put the cash into bonds. The influx of money into
bonds affects the supply that is left, and the prices of bonds go up.
There are no mysteries to the stock market. Stocks and bonds only go up in price
when people buy them. They also only go down when people sell them. A student
once told me I was wrong about this last statement. He said, "Earnings and good
or bad news makes stocks move". This is a common misconception, which can be
easily clarified. It is not earnings, or good or bad news that moves stocks.
When you read bad news on company XYZ you may sell your XYZ stock. If the news
is bad enough a lot of people will sell XYZ and the selling will make the stock
fall. If XYZ had terrible earnings or lost a big lawsuit, and nobody knew about
it, nobody would sell. The stock would not move. If a tree falls on Wall Street
and nobody hears it, does it make a sound? The answer is no!
So, Bonds are up - Stocks are down. Stocks are up - Bonds are down. Are you with
me? Good.
The next thing that must be determined is what you need your portfolio to do
now. As an example you might be looking for growth. Another person with the same
time parameters may need some income from their portfolio. We need to address
this. In the stock market there are sectors, and each sector acts a different
way. For example, there is a utilities sector. These are utility company stocks.
Historically, utility stocks pay dividends (quarterly income payments to
shareholders of record).
If you decided that you need income from your portfolio, you would invest in
stocks in sectors like the utility sector. This way you have stocks that pay
dividends (income). Keep one thing in mind, if a stock pays dividends it will
not offer the same growth potential as a stock that doesn't pay dividends.
Dividend paying stocks are historically more stable than growth stocks. They
don't move as much. They do move, but just not as much. There is a trade off.
If you decide that you are interested in growth, you would invest in sectors
that historically don't pay dividends. You will buy stocks in sectors like the
chip sector, where stocks have seen upward price momentum.
We have covered two steps up to this point. We determined time and current need.
The following step is where most people will lose all their money. This is the
step in which most people will get killed if they do it wrong. This is the step
of managing your portfolio. I'm going to walk you thru a three - month example
of managing your portfolio the right way.
You started your portfolio with 75% of your money in stocks and 25% in bonds.
Thirty days have gone by and the stock market has been cranking. Stocks are
going up and bonds are moving down a little. Your stocks are high and they are
growing in value. Bonds are low. Now, you have a problem. All of a sudden
percentage-wise you have too much money in stocks. You need to get back to
75/25. Lets say you have $2,000 too much invested in stocks. You will take sell
$2,000 worth of stocks, and put that money into bonds. Now you are back to
75/25.
Thirty more days go by, and the market has been spectacular. Stocks are high and
bonds are low. Suddenly, percentage-wise, you have too much money in stocks
again. This time you have $3,000 too much invested in stocks. You need to sell
$3,000 in stocks and buy $3,000 worth of bonds. This takes you back to 75/25.
Your portfolio is growing, but it is doing so uniformly.
Thirty days more go by in the market and we see something that we have never
seen before. Stocks go down. (Never saw that before, Huh?) Percentage-wise you
have too much money in bonds. This time you have $1,000 too much in bonds,
because they have went up value. You will sell $1,000 in bonds while they are up
and buy $1,000 in stocks well they are down.
That was three months in the market I just showed you. Do you realize what you
just did during these three months, without emotion and without really having to
think about it too much? Let me give you a hint. You always hear the same thing,
how do you make money in the stock market? Buy. Where? Sell. Where? Buy low -
Sell high.
Lets talk about what you just did in the above example. The first month, after
thirty days went by, what happened? Stocks went up. What did we do? We sold.
Thirty days latter stocks went up again. What did we do? We sold. Thirty days
more goes by, and stocks dropped in price and what did we do? We bought. We
bought while stocks where cheap.
The example I used here really happed in the stock market. What I just showed
you happened in 1987. It occurred in August, September and October of 1987. In
August of 1987 stocks were cranking. In September of 1987 stock where doing
great, and everyone in the market was making money. Do you remember what
happened in October of 1987? The market went down and most people where
panicking and selling. Utilizing this asset allocation strategy would have
allowed you to buy stocks at some of the best prices in the history of the
market. You would have done so without emotion and without panicking.
What you just learned seems simple. Don't let it trick you. The strength of the
asset allocation system is in its simplicity. Follow the steps and you will get
that much closer to your dreams.
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