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Asset Allocation (Part 2)

POSTED ON JULY 17, 2020     Andoy Beltran

Now, it may be true that investing knows no age. But age has a lot to do with your portfolio construction.

Benjamin Graham tells us that the ideal asset allocation should be 50% bonds and 50% stocks. John Bogle suggests that we allocate our age in bonds, the rest in stocks. The famous Warren Buffett shares that he maintains a portfolio with 10% in government bonds and 90% in index-tracking mutual funds.

These are the Who’s Who in investing, but they have their own strategy when it comes to asset allocation, simply because they have varying personalities, sensitivities, goals, biases and time horizons.

Investing and age

If you ask me, the younger you start investing, the longer your time horizon, the more aggressive you can afford to be. That can also make investing more affordable.

This means that, as far as asset allocation is concerned, you can afford to distribute more funds into more aggressive, longer time-horizoned assets like stocks, equity funds, and even real estate. Say, a 75% exposure in stocks, 20% in bonds, and 5% liquidity in the money market.

But as you age and get closer to retiring, you can start toning down on your aggressiveness and take a more conservative stance by shifting to perhaps 60% of your portfolio in bonds, 5% in the money market, and 35% in dividend-paying stocks.

Of course, this means you’re going to have to give up higher potential returns, but this also means embracing steady gains.

And because numbers don’t lie, let’s try to look at how effective asset allocation is from a returns standpoint:

  • 100% Deposits: A 0.25% annual interest rate will give your P1 million deposit about P25,000 in 10 years, before tax.
  • 100% Bonds: A 10-year bond giving 3.44% yearly will let your P1 million investment earn about P402K in 10 years.
  • 100% Stocks: Using the PSEi’s 10-year average return of 10.7%, your P1 million would have grown to P2.77 million.
  • A portfolio following an asset allocation of 75% stocks, 20% bonds, 5% money market, on the other hand would have given you a blended 10Y Return of 8.73%. In peso terms, given the 10.7%, 3.44% and 0.25% respective average returns in 10 years, it would have grown your P1 million to P2.3 million.

Better performing than cash or bonds, and higher than the inflation rate. Not bad, considering that you now have a solid, well-diversified portfolio which can provide you liquidity, stability and appreciation all at the same time.

Period maintenance

This should be something you should regularly recalibrate, because good stock market returns may leave your portfolio excessively exposed to stocks. Having too much idle cash will bloat your cash component and can hold back the earnings potential of your portfolio.

You should check your portfolio’s asset allocation at least once a year; if it needs to be rebalanced, do it. Have you been promoted? Received a salary increase? So should your investments. Check if you are still investing at least 30% of your income every payday. Plan as a family, or as husband and wife.

Fund management strategies should be dynamic. If you don’t adapt to changes, you could be left behind and your portfolio won’t be able to adjust to “The New Normal.”

From a business standpoint, this also means you get to learn from a time horizon of experience. Whether you win from a successful business or lose from a failed endeavor, what’s important is you move forward by learning from experiences.

Keep looking for opportunities to tap and take advantage of. Like investing, you should keep on learning by not making the same mistakes.

Things to remember

Whether you put your money in paper investments, real estate, businesses, or all the above, asset allocation help you create multiple sources of income because your money is invested in multiple asset classes. Aside from distributing your eggs into different baskets to protect them from risks, it will eventually allow you to get more eggs from different sources too.

Don’t do this just to distribute your funds. Do this because you understand the asset classes you’re putting our money in.

Don’t diversify your portfolio just for the sake of diversifying. Do it because your current portfolio no longer suits your goals. Do this because you now understand that diversification makes it possible to optimize your gains and mitigate risk at the same time.

Do this because you know that by doing so, you are essentially future-proofing and crisis-proofing your portfolio simply by spreading out your assets into various outlets so your money isn’t exposed to a single risk.

You won’t be entirely vulnerable to interest rate increases because you’re not 100% exposed to bonds. You won’t be entirely vulnerable to economic recessions because you’re not 100% exposed to stocks. You won’t be entirely vulnerable to a property bubble because you’re not 100% exposed to real estate.

In fact, interest rate increases, economic recessions and a real estate bubble may actually serve as opportunities to take advantage of.

Basic beginnings

Construct your portfolio by starting with the most basic outlet. Start by saving. Build your emergency fund worth 6 to 12 months’ of expenses and house them in a deposit account, or better yet, a higher-yielding money market fund.

Then, start making your money make more money by adding bonds into the mix. Doing this will help your money make more money by way of fixed coupon payments and capital appreciation. After, buy businesses. Invest in stocks. Doing this long term will make your money work harder by earning thru price appreciation and dividends.

You can’t build a well-diversified portfolio overnight. You do it one payday at a time. One asset class at a time.

Be the best fund manager you can be. The less money you spend on unnecessary stuff, the more money you get to invest. And the more money you invest, the more income streams you create.

Remember that money, when used the right way, can help you make more money. Money doesn’t need to rest, it doesn’t sleep, it doesn’t need vacation leaves, sick leaves, and doesn’t get burned out. Invested the right way, and in the right instruments you fully understand, your money can be your best ally

Learn to let go, because you will only make money when you sell. Learn to part ways with your investments because you are investing for a reason. You don’t invest just for the sake of telling people you are investing. You are investing because you have goals. You want to buy a car. You want to build a house. You want to open a business.

Research, especially when it comes to fees, commissions and charges (cheap does not necessarily mean affordable). Check if these are worth the money. Are you really making money off their services? Are they consistent in managing funds with good returns? Are you better off hiring them compared to you doing it on your own? Do you really have to pay such fees?

Investing should be a source of income and excitement. If it gives you stress, you may not be investing in assets you fully understand, or you may be overdoing yourself. Your investments should fit your personality, experience, sensitivities and time horizon.

And always remember that financial literacy is not confined to seminars, webinars and online tutorials. Financial literacy should be a lifestyle, and one that keeps on evolving for the better.

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