Have you ever wondered if a chef eats his own cooking? Does a doctor take her own medicine? Or, do financial planners invest in the same strategies they recommend to investors?
Recently, a vice president at Morningstar, an investment research firm, wrote about his personal investment portfolio. His asset allocation is basically 93 percent stock, 4 percent cash, and 3 percent bonds. That is an aggressive strategy for anyone.
In comparison, my asset allocation is more moderate, approximately 66 percent stocks, 25 percent bonds, 5 percent real estate investment trusts, and 4 percent cash. Why do I invest this way? Well, the answer is based on my unique goals and circumstances; and, based on the lessons I have learned:
Over most long-term periods, stocks have outperformed bonds and bonds have outperformed cash. Since I hope to work (and live) for many more years, I invest for long-term growth. However, I balance my portfolio with conservative investments and savings as I still have a family and a small business that rely on me.
I have generally stuck with a “5-year” mantra that any funds needed within five years or less should not be at risk in the stock market. I’m OK with the opportunity cost to avoid a big hit on funds I will expend soon.
Diversification. Love it or hate it, but apply it. My father used to describe his investment philosophy as “plain vanilla.” It took me a while to get it. Here was a seasoned investor with a Ph.D-level intellect who was espousing a boring investment philosophy based on diversification, long-term patience, and trading discipline. And like my father, I prefer mutual fund investments. He called them “the greatest invention of the 20th century.”
We live in a global marketplace of investment opportunities. John Bogle, the founder of the Vanguard Group, debates that investors get sufficient global diversification when they invest in multinational companies like Coca Cola or Johnson and Johnson. Nonetheless, I think my portfolio’s risk/return profile is improved by including both domestic and foreign stock and bond funds.
An asset allocation strategy should not be static. While I maintain core positions in U.S. large company stocks and U.S. intermediate-term bonds I also have strategic allocations in my portfolio. In the face of rising interest rates I have focused on short- and intermediate-term bonds, mostly corporate. In addition to developed and emerging markets, I have added international small company stocks.
Costs matter. Keeping trading and fund management costs low means I get to keep more return on my investments.
Rebalance a portfolio based on disciplined parameters. I could make bad decisions if I left buy/sell decisions to my emotions. For example, I am witnessing a familiar pattern repeat itself today as investors are increasing their stock exposure, investing in hot individual stocks and aggressive mutual funds. Stretching for more return and losing focus of risk are tell-tale signs of a late bull market.
When the next correction hits, and as investors rush for the exit, I will hit the rebalance button as a buyer.