How do I Allocate My Investments?

By Bob Moeller
WEAC Member Benefits

November 2003

Financial Planning Seminars
Achieving Financial Independence

Although possibly recovering, the stock market is still way down from previous highs, and members I met with this past summer have suffered losses. They are hesitant and reluctant to invest in stocks. Yet, alternative investments such as CDs, bonds, etc., are paying terribly low rates of return.

Of course, everyone believes some diversification in investments is a good idea, but how do you go about it? In just one issue of Investment Advisor magazine, the following recommendations were made by various “experts” regarding stock market allocations. These people are all respected authorities on asset allocation. These recommendations were in the July 2003 issue. Six months from now you can rest assured the recommendations will change. (Unstated percentages would be in cash.)

• L. Anderson of LPL Financial recommends 73% in stocks, 24% in bonds.
  
• G. Shilling, of A. Gary Shilling & Co., recommends 20% stocks, 70% bonds.
  
• R. Bernstein, of Merrill Lynch, recommends 45% stocks, 45% bonds.

So much for agreement on how much you should invest in stocks.

Which of these gentlemen is right? Got me! The lesson here is that you have to put some emphasis on your personal emotions and needs. As I frequently mention in my seminars, the most important thing about your investments is that you have to sleep with them every night. If you can’t accept the risk, or don’t understand the investment, don’t do it!

I believe most members want an understandable allocation system that reduces risk as they get older. I also find, after talking to hundreds of members so far this year, that members prefer not to have to spend a lot of time deciding on what to invest in. As my wife puts it, “I’d rather play tennis.” Finally, the statistics show clearly that index funds with their lower management fees are difficult to beat over a longer period of time. Combining all of the above, I recommend the following as guidelines – not absolutes, but guidelines – you can follow for the rest of your life. They lead to more aggressive investing when you are young and more conservative allocations when you are older. They do not take much time once you understand the basics. The fees are minimal, and you can indeed make the decisions yourself.

• • •

Take your age as a percentage, plus or minus 10% depending on how willing to take risks you are. For example, if you are 50, the percentage to use would be 40% to 60%. That is the percentage you want in stable investments. Stable investments today include short-term bonds or bond funds (you do not want long-term bond funds at today’s interest rate levels, because as interest rates go up you lose money in long-term bonds), fixed-interest products like CDs, the guaranteed fixed-interest of your TSA, money funds, I-Bonds and other government bonds, etc.

The balance of your money should be in the stock market.

I recommend you use no-load mutual funds either directly or through a good TSA or Roth IRA, or use exchange-traded funds that trade like stocks. A good approach is to put 40% to 50% of the balance (after doing the stable allocation) in a large company index fund such as the Vanguard 500 Index Fund. Put 20% to 30% in a mid-cap index fund and 20% to 30% in a small-cap index fund. If you want to be a little more conservative, select funds designated by Morningstar as “value” as opposed to “growth.” If you are young, speculate with a small portion. For further diversification, if you use the smaller percentages above, you have some money left to allocate. Consider real estate investment trust funds and/or international funds for a small portion of your allocation.

As a general rule, the Vanguard Fund family is the least expensive way to invest in terms of annual fees. Vanguard has all of the above types of funds. There are several other excellent no-load fund families, like T. Rowe Price, Fidelity, TIAA-CREF, etc.

What do you end up with here? A balanced allocation based on your age and risk tolerance that uses inexpensive ways to essentially invest in the entire stock market and does not require a lot of your time.

Plan on reviewing your allocation totals once a year or so and changing allocations as necessary. Many people achieve the change by simply earmarking new money sent in to the fund. Make sure you include all your investments as one allocation package. Don’t try to allocate each TSA or IRA you, or you and your spouse, own separately.

Posted November 10, 2003