David Cordell
Some thoughts about investing.
Before starting, keep in mind that stocks outperform bonds and money market instuments over the long haul.
Those of you who have a significant amount of money in the stock market might consider making some adjustments. Since the market has risen significantly recently, it has probably increased the proportion of your wealth that is in the stock market, whether in individual stocks, or in mutual funds or exchange traded funds that are equity (stock) based.
An old rule of thumb was to calculate the percentage of your portfolio that should be invested in equities as follows: subtract your age from the number 100. If you are 73, 100-73=27, thus 27% of your portfolio should be in equities. However, this formula fails to consider your risk tolerance, i.e. how willing you are to experience volatility in equities -- the ups and downs of the market.
A more reasonable rule of thumb, but still a rough rule of thumb, is to consider your risk tolerance with these formulas:
- conservative: 100-age
- moderate: 120-age
- high: 140-age.
Part of risk tolerance relates to your own psyche, how upset you would be at losing money, and part relates to your financial situation. For the latter, consider that a 73-year-old with a billion dollars can afford to have a higher percentage in equities than a 73-year-old with $100,000 because the billionaire will still be rich even if she loses half of her money in the market. There are other factors, such as one's interest in providing a death estate for the benefit of family, church, charity, etc.
Note also that all equities are not the same. Utility companies are less risky than high tech companies. And a highly diversified equity portfolio is less risky a portfolio consisting of a handful of stocks in the same industry.
Most people of our age are better off to invest in a mutual fund or exchange traded fund that is based on an index, like the Standard and Poors 500. People who can't stand the boredom of an index fund might consider puting a high percentage of their equity allocation in an index fund and a small percentage in a sector fund, which is a fund that invests only in one sector of the market, for example, energy companies or financial companies. They might even want to allocate a small percentage of their equity allocation to individual stocks.
So, back to the point, whatever your choice of an equity percentage, it changes constantly, usually increasing because over time stocks tend to outperform bonds, money market securities, etc., thus they represent a higher and higher percentage of the portfolio.
Simple example: you have $100,000 with $50,000 in stock and $50,000 in bonds, i.e. 50% in stock. During the year, the stock value increases by 10% and the bond value increases by 5%. Now your portfolio is $55,000 in stock and $52,500 in bonds for a total of $107,500. Now your stock represents over 51% of your portfolio. That doesn't sound like much of a change, but what if the stock return is really good, much higher than 10%, and what if the time frame extends beyond one year? In the meantime, the formulas above indicate that you should adjust your stock percentage to decrease over time, not increase.
So, what should your portfolio balance be, and has your portfolio fallen out of balance?
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