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Is Your Portfolio Right for You?

Posted: Brandon Arns

The previous blog I wrote had some general investing advice for those just starting out. In this blog we’re going to drill one level deeper.

A Simple Investing Framework

There are two things you need to know before you start investing.

  • What is the money for?
  • How much risk can I tolerate?

Whenever we get a new client, the first thing we do is create a financial plan. We work with them to come up with different goals, broken up by needs and wants. For example, the most common goal is to spend X amount of dollars each year in retirement. Secondary goals may be to cover various medical bills, pay for kids/grandkids college, buy a home, donate to charity, etc.

We assign a dollar value for each of those goals, determine how much they have today, and try to figure out how to make that money grow in order to accomplish those goals with the highest probability of success. It’s AFTER all of this that we finally start deciding how to manage the portfolio.

We may determine that in order to best achieve a particular set of goals, the client needs to be aggressive, putting the bulk of the portfolio into risky stocks. However, there’s one more consideration. Even though the model might recommend an aggressive allocation, we need to consider the client’s temperament to losses. The fact of the matter is that when you take more risk, losses are GUARANTEED to happen. If the client is unable to hang on to their portfolio through these difficult times, it may make sense to revise their goals, and invest in a more conservative portfolio.

This is the same framework that you should use when deciding how to invest your money.

What is the money for?

After you’ve chosen what the money is for, determine if it is a long-term or short-term goal. If the time frame is within 5-10 years, you really shouldn’t have very much in stocks. Historically, stocks have had several 5-10 year periods of making 0 or even negative returns. You don’t want your home down payment cut in half just before you buy.

A good alternative would be to put your money into bonds. Bonds pay a fixed interest payment each year and if you only buy good credit bonds (such as treasuries or investment grade corporates), there is a much smaller chance of losing money. Of course, the tradeoff is that you’re only able to earn about 2-3% today in bonds. Still better than leaving it in cash. A good example of this investment would be the Vanguard Total Bond Market ETF (Ticker: BND) which today yields about 2.3% with very little risk.

What about a longer-term goal, such as retirement? For most, this will be their largest goal, the bulk of which will be funded from your 401k/IRA. In general, I’d recommend 100% stocks in this situation because you can’t touch your 401k or IRA until you are 59 ½ without penalty. So, for those in their 40s and below, you can take plenty of risk because you have plenty of time to recover.

One further step I’d recommend is to buy stocks from all over the world, not just in the U.S. The U.S. and the rest of the world have historically performed in cycles with U.S. dominating in some periods like the last 10 years, and international markets dominating in the 10 years prior. Most 401ks have at least one international developed market option and one international emerging market option, both of which are suitable long-term investments.

How Much Risk Can I Tolerate?

The caveat to all of this is your personal temperament for risk. It is INEVITABLE that one or all of these investments will find themselves down 30% or more (conservatively). If you don’t think you can handle that, that’s ok. Simply buy some bonds to temper that volatility. Better yet, you should probably just put your money in a target date fund that a professional manages for you. These are the funds which have names that end in a retirement year such as “2055”. The best portfolio on a spreadsheet is not necessarily the best portfolio for you.

Take a look at your savings. Is your portfolio right for you? If you’re sitting in cash the answer is probably no, and if you’re in all stocks the answer again is probably still no.

The information listed above is simplistic, but a good starting point for most people. There are so many other steps that we as money managers think about, such as the specific types of stocks and bonds that we buy, when we buy them, and if there are investments outside of stocks and bonds that can compliment a portfolio. Not all of this is necessary for everyone, especially early on, but if you are reaching a stage where a bit more detail is needed, we’d be happy to help. If you have additional questions, feel free to email me at brandon@wjwealth.com.

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