Stocks vs. Bonds and Cash: How Much Should You Have?

Rebuild Your Wealth on Solid Ground (Part 2 of 4):

Deciding on the amount you should have in stocks vs. bonds and cash (known as “asset allocation”) is one of the most important decisions an investor can make. The goal of “asset allocation” is to earn high enough returns to achieve your goals, while limiting the amount of risk that you’re taking.

Over long periods of time (say, ten years or more), stocks almost always return more than bonds. Because stocks are shares of ownership in businesses, they reflect the long term trends of growth in the economy. People invest in stocks because they want their assets to grow. If you are younger and are investing for the distant future (such as retirement that’s at least 15 or 20 years away), and won’t need to withdraw money until then, you can afford to have a fairly high percentage allocated to stocks—even though you will probably go through some major stock market downturns along the way.

If you are closer to the time when you’ll need to start using the money you’ve invested, such as within 15 years of retirement, you should have a lower weighting in stocks than you did when you were younger. This is because in the short run, the stock market has a lot of risk. We don’t have to look any further back than the last couple years to see how much stocks can decline at times. As you approach retirement, you should gradually reduce your weighting in stocks. The best times to do this are during periods when the market has been rising for a while rather than after a big selloff in the market. After you retire, you will probably still need to have a modest allocation to stocks to be able to keep up with inflation.

Bonds and cash are a counterbalance to stocks in your portfolio. These are your preservation and income assets. The biggest long term risk to bonds, assuming you’ve invested in high credit quality bonds, is inflation. It would be very appealing to retire with, say, a $1 million bond portfolio that gives you $50,000 in annual interest income—just the amount you need—and just avoid the stock market altogether. The problem is that inflation will reduce the buying power of that $50,000 each year. In five to ten years, you’ll be drawing down on the principal or looking for a job because the interest income from your bond portfolio can’t pay your bills.

So—what should your personal asset allocation be? What’s the formula to figure it out? For people over 45, the general rule of thumb says that the percentage you have in stocks should be 100 minus your age. However, the best allocation for you may not be quite that simple. For example, if you are behind on the amount you have saved and invested, you may need to have a somewhat higher percentage in stocks at age 50 in order to increase your potential for having enough money when you retire. On the other hand, if you are 55 and worry a lot about losing money during market downturns, you may only be able to handle a small percentage in stocks—and perhaps lower your lifestyle expectations for retirement.

There is nothing wrong with tactically, or temporarily, deviating modestly from your asset allocation target to try to avoid temporary losses or to take advantage of selloffs in the market. However, the temptation we all have is to follow our emotions (and the emotions of the “experts” on the business programs) and sell stocks after the market is already down, and get too optimistic when the market has been rising for an extended period. Try hard to avoid acting on these “knee-jerk” emotions.

A much better approach is to rebalance periodically. This means selling a little of the asset class that has increased its weighting in your portfolio recently, and buying a little of the one that has declined—to get back to your target allocation. If you do that at least annually, you will usually be “buying low and selling high.”

At Tampa Asset Management, we will recommend an asset allocation that we’ve designed specifically for your needs. We’ll pay a lot of attention to how you feel about investing and your personal “go to sleep at night” factor. Over time, we’ll help you change your asset allocation as you get closer to retirement, and as you enter it. It’s part of the solid ground that you should build your wealth on.

Next in the “Rebuild your Wealth on Solid Ground” series (Part 3 of 4):
Guidelines for investing in stocks, bonds, CDs, and cash - while keeping costs low.

Have A Good Investment Plan. Follow The Plan.

Rebuild Your Wealth on Solid Ground (Part 1 of 4):

Feeling shell shocked? You aren’t alone. After the great collapse of the stock market in 2008 and early 2009, most investors are looking for a way to rebuild their assets. Unfortunately, many people are so shaken by the losses they’ve incurred that they don’t know how to invest now without taking more risk than they can stomach. Some have sworn off investing entirely, vowing to stay in cash and CDs. Others feel like they have missed the rebound in stocks, so now they are just…waiting. More than a few are questioning the whole concept of investing, after the “lost decade” that they have just been through.

Don’t feel bad if any or all of these describe you. This has been a treacherous period for almost all investors. Retirement savings, including 401(k)s and IRA rollovers were cut nearly in half for many investors across the country, although they have rebounded somewhat since March.

A good investment plan is as important to your financial success as a good map is when you’re traveling in an unfamiliar part of the world. You wouldn’t fly to Sydney, Australia, rent a car, and then set out driving across the continent to Perth without a roadmap—would you? You might end up chasing kangaroos in a rainforest.

Just like a roadmap, a good investment plan identifies your destination (your investment goal), where you are now, and the best road to take to get from here to there. Of course, a roadmap can’t forecast all the problems you might encounter along the way—heavy rain storms, a section of the highway that’s closed, or a flat tire. But it can help you adjust, deal with those problems when they come, and then continue along in the right direction to reach your intended destination.

Simple, right? But what does a good investment plan have in it? The answer is that it has everything that is important and relevant to reaching your goal. The essential elements include:

• A clear statement of your investment objectives. These are the tangible reasons you are investing—the amount of inflation-adjusted income you’ll need when you retire, paying for your children to go to college, or buying a vacation home in North Carolina.


• An evaluation of your current assets—individual stocks, mutual funds, CDs, municipal bonds, 401(k), IRAs, and any other assets, as well as your debts. This is the starting point.


• An assessment of how much you’ll be able to save and invest, as well as any other sources of income or lump sum payments you expect.


• A realistic assessment of risk—including identifying current weaknesses in your portfolio, the risk of loss from investing, future inflation, debt risk, and the risk of running out of money when you retire. They can’t all be neatly quantified or eliminated, but you can work to prepare for them.


• A target for asset allocation (% to invest in stocks vs. bonds, CDs, and cash). This depends on a lot of things—your age, when you want to retire, how far short of your goals you are now, your “go to sleep at night” factor, and some consideration of where the markets are now.


• A diversification plan for your growth assets (across large cap, mid cap, and small cap U.S. stocks, as well international and emerging markets stocks).


• A preservation plan for your bonds and CDs, which takes into account potential changes in inflation and interest rates, credit risk, and your tax bracket, and includes a policy of laddering bond maturities from short to long.


• Investment guidelines for what to do in good and bad market conditions—such as when stocks go up substantially, or enter a sustained downturn, or when interest rate changes affect bond prices.


• A specific plan to reduce or eliminate debt.

It should be clearly written (yes, written down on paper), designed specifically for your needs, and should not be built on somebody’s forecasts of future market performance.

Do you have a good investment plan that is designed just for your needs? Your future is too important to you to avoid this first step. If you need to rebuild after the market decline of 2008, do so on solid ground—starting with a good plan.

Next in the “Rebuild your Wealth on Solid Ground” series (Part 2 of 4):
Stocks vs. Bonds and Cash: How Much Should You Have?