asset allocation http://www.wisebread.com/taxonomy/term/7592/all en-US How One Mediocre Investor Prospered After the Market Crash http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/how-one-mediocre-investor-prospered-after-the-market-crash" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/iStock-516182744.jpg" alt="Learning how a mediocre investor prospered after the market crash" title="" class="imagecache imagecache-250w" width="250" height="141" /></a> </div> </div> </div> <p>The <a href="http://www.wisebread.com/the-3-rules-every-mediocre-investor-must-know" target="_blank">mediocre financial advice</a> I've offered in my last few posts boils down to this: Use low-cost funds, establish an appropriate asset allocation, and rebalance it annually.</p> <p>It's not new advice. My own portfolio was strongly influenced by it back in the early 1980s. By the 1990s, it was pretty much the standard advice you would get anywhere. Many studies at the time showed that a very simple portfolio &mdash; just an S&amp;P 500 index fund, plus a long-term bond fund &mdash; tended to outperform managed funds, especially after the costs of the managed funds were taken into account.</p> <p>I haven't seen as many studies in the years since the financial crisis, so I thought I'd take a quick look at how this sort of basic asset allocation held up in the aftermath.</p> <p>Most people date the financial crisis from 2008, but I tend to date it from June of 2007, because that's when I found out that I'd be losing my job. For that reason, the graphs below run from then through the latest data available as of March 29, 2017.</p> <p>As it turns out, a <a href="http://www.wisebread.com/the-surprising-truth-of-investing-mediocre-advice-is-best" target="_blank">mediocre portfolio</a> held up pretty well.</p> <h2>Criteria for success</h2> <p>To decide whether a particular style of investing is a success, it helps to know what your goals are. Most people would include &quot;maximum return&quot; as at least part of their goal, but instead, I suggest that your portfolio provide an investment return that supports your specific life needs.</p> <p>A portfolio that comfortably beats inflation is part of that. It's also a plus if the portfolio doesn't swing wildly in value &mdash; in case your circumstances require you to cash out a significant amount on an emergency basis. It's nice, too, if the portfolio provides a mix of income and growth, so that if changes in what's in fashion among investors push one category of stocks up or down, the overall value of your portfolio doesn't take too big of a hit. (Personally I've always had a sneaking preference for income, even though tax policy has often favored growth.)</p> <p>With those criteria in mind, let's look at how some of the pieces of a mediocre portfolio have done.</p> <h2>Pieces of a mediocre portfolio</h2> <p>The most basic mediocre portfolio is just an S&amp;P 500 index fund and a long-term bond fund, with the ratio between those two gradually shifting from mostly stocks (for a young person) toward mostly bonds (for someone who has already retired).</p> <h3>Stock market investments</h3> <p>The value of an S&amp;P 500 index fund dropped dramatically during the crisis itself, but it hit bottom well before the end of the recession, recovered all of its losses by 2013, and is now about 50 percent above where it started &mdash; meaning that on stock price alone, you've got an annual return of well over 4 percent. With dividends reinvested, your annual return comes to nearly 7 percent (take a look at the 10-year average annual return of your favorite S&amp;P 500 index fund).</p> <p><iframe src="//fred.stlouisfed.org/graph/graph-landing.php?g=dyOc&amp;width=605&amp;height=340" scrolling="no" frameborder="0" style="overflow:hidden; width:670px; height:525px;" allowtransparency="true"></iframe></p> <p>(Source: <a href="https://fred.stlouisfed.org/graph/?g=dbdN" target="_blank">St. Louis Federal Reserve</a>)</p> <h3>Bond market investments</h3> <p>There isn't an exact bond-market equivalent for the S&amp;P 500 index fund, so it's a little hard to say how your investments would have done during the crisis and since. (I poked around at a few major mutual fund companies and found average annual total returns on various long-term bond funds for the past 10 years ranging from 3.6 percent to 6.1 percent, depending on the fund.)</p> <p>The return on a bond fund depends on interest rates. If you buy a bond that pays X percent and rates go up, your old bond is worth less (because otherwise people will just buy the new bond that pays more). Conversely, if rates go down, your old bond is worth more.</p> <p>With that in mind, here's a graph of the interest rate paid on a U.S. government 10-year treasury bond:</p> <p><iframe src="//fred.stlouisfed.org/graph/graph-landing.php?g=dyOf&amp;width=605&amp;height=340" scrolling="no" frameborder="0" style="overflow:hidden; width:670px; height:525px;" allowtransparency="true"></iframe></p> <p>(Source: <a href="https://fred.stlouisfed.org/graph/?g=dbfK" target="_blank">St. Louis Federal Reserve</a>.)</p> <p>Long-term interest rates dropped steadily before and during the recession. They rebounded modestly as the recession wound down, but then plummeted as it became clear that the economy needed, and would continue to need, extraordinary support from the Federal Reserve. Even now, long-term rates are about half what they were before the crisis began.</p> <p>The upshot is that the value of bonds purchased before the crisis would have soared during the crisis. Bonds purchased during the crisis would also have gone up. Bonds purchased in the aftermath might be up or might be down, depending on exactly when they were bought.</p> <h2>Rebalancing</h2> <p>If you'd just had a portfolio of stocks or bonds, you'd have done ok. Your stocks would have gone down a lot, but they'd have eventually recovered. Your bonds would have gone up a lot, and would have since eased off. But the mediocre asset allocation is more than that. The essence of a mediocre asset allocation is annual rebalancing.</p> <p>At the end of 2007, and again at the end of 2008, you would have sold some of your bonds &mdash; which would have jumped a great deal as interest rates fell ahead of and during the recession &mdash; and shifted that money into depressed stocks to restore your asset allocation.</p> <p>New stocks purchased on the last day of 2008 would have been bought with the S&amp;P 500 at 891 (down from close to 1,500 when you started). At the recent price of 2,359, those shares are up 165 percent. At the same time, you would have harvested much of the gains in your bond portfolio.</p> <p>Really, the rebalancing is where the magic is.</p> <h2>Success</h2> <p>As I mentioned at the beginning, the criteria I'm using as indicators of success are return, stability, and providing a mix of income and growth.</p> <p>The mediocre portfolio did a fine job of providing a return &mdash; especially if you rebalanced annually, thereby automatically buying stocks when they were at their lows.</p> <p>Stability is always a problematic goal, because it's almost the opposite of growth &mdash; the most stable portfolio would be one invested 100 percent in cash, which would show no growth at all. The point here, just as it is with return, is not maximum stability, but rather a degree of stability that supports your life goals. Here again, the mediocre portfolio did fine, especially for older people with a larger bond portfolio, which is where it is most important.</p> <p>Finally, the mediocre portfolio did a fine job at balancing income with growth. An S&amp;P 500 index fund has produced a pretty good yield, especially compared to cash and bonds during this period of historic lows in interest rates. Annual rebalancing will have automatically shifted money out of bonds as interest rates fell (reducing the fraction of the portfolio invested where income is low) and future rebalancing will be shifting money back into bonds as interest rates rise.</p> <p>I would hesitate to call its performance better than mediocre, but that's really the point: A mediocre investment portfolio, providing mediocre performance, is all it takes to support your life goals.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-3-rules-every-mediocre-investor-must-know">The 3 Rules Every Mediocre Investor Must Know</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required">5 Ways to Invest Like a Pro — No Financial Adviser Required</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/want-your-investments-to-do-better-stop-watching-the-news">Want Your Investments to Do Better? Stop Watching the News</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/your-401-k-is-not-an-investment">Your 401(k) is not an investment</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation bonds financial crisis low-cost funds mediocre investments performance s&p 500 stock market Tue, 02 May 2017 08:30:11 +0000 Philip Brewer 1938294 at http://www.wisebread.com 5 Ways to Invest Like a Pro — No Financial Adviser Required http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/5-ways-to-invest-like-a-pro-no-financial-adviser-required" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/iStock-500538951.jpg" alt="Man learning how to invest like a pro without a financial adviser" title="" class="imagecache imagecache-250w" width="250" height="140" /></a> </div> </div> </div> <p>Investing can be intimidating. There's a unique language, with expense ratios, ETFs, and dollar-cost averaging &mdash; oh my! And there's a lot at stake, like your retirement. (See also: <a href="http://www.wisebread.com/beginners-guide-to-reading-a-stock-table?ref=seealso" target="_blank">Beginner's Guide to Reading a Stock Table</a>)</p> <p>However, at the risk of sounding like a home repair store commercial, you can do this and we can help. With the following five keys, you'll be well on your way toward becoming a confident, successful, do-it-yourself investor.</p> <h2>1. Commit to the market</h2> <p>The stock market has been on a tear. Since bottoming out in March 2009, it nearly tripled in value by the end of 2016. And since the start of this year, it has only climbed higher. Unfortunately, for many people, it doesn't matter. According to a recent Gallup poll, about half U.S. adults are not investing in the market.</p> <p>Some waffle. They're in when it seems safe; they're out when trouble strikes. But pros don't waffle. They're in it for the long haul because they know that as a long-term investment, the U.S. stock market has delivered average annual returns of nearly 10 percent.</p> <h2>2. Know your goal</h2> <p>The most common investment goal is retirement. It that's your goal, make it as specific as possible. How much money do you want to have? By when? And how much do you need to invest each month in order to get there? These questions can feel overwhelming at times, but you need to answer them in order to get a clear picture of your path to a secure retirement. (See also: <a href="http://www.wisebread.com/how-much-should-you-have-saved-for-retirement-by-30-40-50?ref=seealso" target="_blank">How Much Should You Have Saved for Retirement by 30? 40? 50?</a>)</p> <h2>3. Determine your optimal asset allocation</h2> <p>While many of the headlines in the investment press are about which investments to choose, there's a different factor that'll have an even greater impact on your investing success. It's making sure you've determined your <a href="http://www.wisebread.com/the-surprising-truth-of-investing-mediocre-advice-is-best?ref=internal" target="_blank">optimal asset allocation</a>.</p> <p>Asset allocation refers to how you divvy up the money you invest between asset classes, with the two most important ones being stocks and bonds (preferably, stock and bond mutual funds, since mutual funds enable you to hold a diversified &quot;basket&quot; of stocks and bonds).</p> <p>Generally, when you're young, your portfolio should tilt more toward stocks. Yes, your portfolio will experience sharper ups and downs, but you should have the time to ride them out, and a higher-risk portfolio should lead you to higher returns. As you get older, you would be wise to reduce stock exposure and increase your allocation to bonds. (See also: <a href="http://www.wisebread.com/the-basics-of-asset-allocation?ref=seealso" target="_blank">The Basics of Asset Allocation</a>)</p> <h2>4. Choose an investment selection process</h2> <p>Pay no attention to headlines touting &quot;This Year's Top Mutual Funds&quot; or &quot;Why You Must Own Gold Now.&quot; And tune out all hot tips from your brother-in-law or coworker. What you need is a trustworthy investment selection <em>process</em>.</p> <p>You could keep it super easy by choosing a target-date mutual fund. These funds have years as part of their name, such as the Fidelity Freedom 2040 fund. Just choose the fund with the year closest to the year you intend to retire. Its stock/bond allocation will be what the mutual fund company thinks is the appropriate mix for someone with that much time until retirement, and that allocation is automatically made more conservative over time. Target-date funds aren't perfect, but they get a lot of the big picture decisions right.</p> <p>If you prefer a more hands-on approach, you could do your own research and choose <a href="http://www.wisebread.com/why-warren-buffett-says-you-should-invest-in-index-funds?ref=internal" target="_blank">index funds</a> to build a portfolio that reflects your optimal asset allocation.</p> <p>Or, you could subscribe to an investment newsletter, some of which cost far less than the fees charged by financial planners. Investment newsletters usually offer a number of different strategies and then tell you what to invest in. You're still a do-it-yourself investor. You maintain your own account and make your own trades, but you follow the investing process outlined by the newsletter. (See also: <a href="http://www.wisebread.com/should-you-trust-your-money-with-these-4-popular-financial-robo-advisers?ref=seealso" target="_blank">Should You Trust Your Money With These 4 Popular Financial Robo-Advisers?</a>)</p> <h2>5. Understand the terrain ahead</h2> <p>One of the most important roles a financial adviser plays is seen during market downturns. That's when the best become therapists, speaking calm words of wisdom into the lives of frightened clients. You could serve the same role for yourself with a little understanding of how the market works.</p> <p>If you hear that the market turned in a great performance in a certain year, it's easy to make the mistake of assuming this wonderful result came about through a smooth, yearlong, upward ride. It doesn't usually work that way.</p> <p>Expecting some turbulence can help calm your fears and keep you from selling when the market gets wobbly. (See also: <a href="http://www.wisebread.com/want-your-investments-to-do-better-stop-watching-the-news?ref=seealso" target="_blank">Want Your Investments to Do Better? Stop Watching the News</a>)</p> <p>Taking all of the steps above will get you headed in the right direction. You have a plan. Now put your plan into action and stay with it. The longer you invest, the more confidence you'll gain and the more comfortable you'll become at being a do-it-yourself investor. (See also: <a href="http://www.wisebread.com/the-only-4-things-you-need-to-do-to-start-investing?ref=seealso" target="_blank">The Only 4 Things You Need to Do to Start Investing</a>)</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/matt-bell">Matt Bell</a> of <a href="http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash">How One Mediocre Investor Prospered After the Market Crash</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/are-we-headed-toward-a-bull-or-bear-market">Are We Headed Toward a Bull or Bear Market?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/learn-how-to-invest-with-these-5-stock-market-games">Learn How to Invest With These 5 Stock Market Games</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/make-smarter-investments-by-mastering-this-simple-ratio">Make Smarter Investments by Mastering This Simple Ratio</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation diy investor Do It Yourself goals investment selection retirement planning stock market Mon, 17 Apr 2017 09:00:09 +0000 Matt Bell 1928275 at http://www.wisebread.com Your 401K in 2017: Here's What's New for You http://www.wisebread.com/your-401k-in-2017-heres-whats-new-for-you <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/your-401k-in-2017-heres-whats-new-for-you" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/iStock-502449548.jpg" alt="Learning what&#039;s new for your 401K in 2017" title="" class="imagecache imagecache-250w" width="250" height="140" /></a> </div> </div> </div> <p>There aren't many 401K rule changes to keep up with this year, but that doesn't mean you can't bring about some of your own positive changes to your retirement savings. Let's take a look at what you need to know to make the most of your 401K in 2017.</p> <h2>No Changes in the Contribution Limits</h2> <p>The amount the IRS allows you to contribute to a 401K plan this year remains as it was last year &mdash; $18,000 if you're younger than 50, or $24,000 if you're older. However, the Feds did make two changes to the retirement savings landscape, which pertain to people on either end of the income spectrum.</p> <h3>1. More May Qualify for the Saver's Credit<strong> </strong></h3> <p>Low and middle-income earners should be aware of the <a href="https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit" target="_blank">Saver's Credit</a>, a tax benefit that rewards those who save for their later years through a 401K or IRA. Depending on your income and filing status, the credit is worth 10%, 20%, or 50% of up to $2,000 of contributions per person (for married couples, that means up to $4,000 of contributions).</p> <p>Married couples filing joint returns can claim at least a 10% credit as long as their adjusted gross income (AGI) is no more than $62,000. That maximum income amount is $500 more than in 2016, so more households should qualify. However, the most generous 50% credit is allowed only for those couples making no more than $37,000 &mdash; the same threshold as in 2016.</p> <p>The credit/income limits for married couples filing jointly are:</p> <ul> <li>50% if AGI is $37,000 or less</li> <li>20% if AGI is $37,001&ndash;$40,000</li> <li>10% if AGI is $40,001&ndash;$62,000</li> </ul> <p>For singles, or married couples filing separate returns, the maximum amount you can earn and still qualify for a credit is $31,000, which is $250 higher than in 2016. In order to qualify for the maximum 50% credit, your income has to be no higher than $18,500.</p> <p>Here are the details:</p> <ul> <li>50% if AGI is $18,500 or less</li> <li>20% if AGI is $18,501&ndash;$20,000</li> <li>10% if AGI is $20,001&ndash;$31,000</li> </ul> <p>Keep in mind, a tax credit is much more valuable than a tax deduction because it is a dollar for dollar reduction of taxes.</p> <h2>2. Higher-Income Earners May Get More</h2> <p>On the other end of the income spectrum, the IRS expanded the contribution parameters pertaining to the retirement plans of well-paid workers. For example, contributions &mdash; by the employee and/or his or her employer &mdash; are limited by how much an employee is paid in total. In 2017, the amount of compensation on which contribution amounts can be based was increased by $5,000 to $270,000, and the maximum total contribution amount was bumped up by $1,000 to $54,000.</p> <h2>What Changes Will You Make?</h2> <p>Even if the two changes noted above don't pertain to you, that doesn't mean you need to &mdash; or should &mdash; stay the course with your retirement savings. The start of a new year is a good time to re-evaluate your goals and see if you're on track.</p> <p>Here are two areas to review.</p> <h3>1. How Much You Need<strong> </strong></h3> <p>Do you know how much you should have saved by the time you retire? Do you know how much that means you should be saving each month right now? If not, take a few minutes to run some numbers. If you're not saving enough, consider increasing your contributions.</p> <h3>2. How You Should Allocate</h3> <p>Do you know your optimal asset allocation? That pertains to how much of your investment portfolio should be in stocks, and how much in bonds (or stock and bond mutual funds). Vanguard offers a well-designed, free <a href="https://personal.vanguard.com/us/FundsInvQuestionnaire" target="_blank">asset allocation questionnaire</a>, so give it a try. Then try to bring your portfolio more in line with your optimal asset allocation.</p> <p>While tax credits and employer contributions are significant benefits, the most important factors that determine your investing success are the amount of money you save each month, and whether your asset allocation is appropriate for someone of your age and risk tolerance. Take the time to evaluate your individual retirement savings scenario, and see how you can make it even better for 2017.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/matt-bell">Matt Bell</a> of <a href="http://www.wisebread.com/your-401k-in-2017-heres-whats-new-for-you">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-3"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/start-planning-now-for-when-your-target-date-fund-ends">Start Planning Now for When Your Target-Date Fund Ends</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/what-you-need-to-know-about-the-easiest-way-to-save-for-retirement">What You Need to Know About the Easiest Way to Save for Retirement</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-important-things-to-know-about-your-401k-and-ira-in-2016">5 Important Things to Know About Your 401K and IRA in 2016</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-save-for-retirement-without-a-401k">How to Save for Retirement Without a 401K</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Retirement 401k Adjusted Gross Income asset allocation bonds changes contribution limits employers investing saver's credit stocks Mon, 20 Feb 2017 10:00:11 +0000 Matt Bell 1892607 at http://www.wisebread.com 5 Crucial Things You Should Know About Bonds http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/5-crucial-things-you-should-know-about-bonds" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/money_000039524102.jpg" alt="crucial things you need to know about bonds" title="" class="imagecache imagecache-250w" width="250" height="140" /></a> </div> </div> </div> <p>Be honest: How much do you actually know about bonds? If you're stammering for an answer, here's your chance to raise your bond IQ. For starters, bonds are an essential part of every investor's toolkit. They can provide stable returns to help offset volatility in other parts of your portfolio. (See also: <a href="http://www.wisebread.com/the-5-best-reasons-to-start-investing-in-bonds-now?ref=seealso">The 5 Best Reasons to Start Investing in Bonds Now</a>)</p> <p>Depending on how old you are, you may not own many bonds right now, but you likely will someday. It's important you at least understand the basics.</p> <h2>1. A Bond Is an &quot;I Owe You&quot;</h2> <p>Shakespeare famously wrote, &quot;Neither a borrower nor a lender be.&quot; Apparently, he knew a lot about personal finance (it's definitely best to go easy on the borrowing), but not so much about investing. When you buy bonds, that actually makes you a <em>lender</em>, and this form of lending can be a very good thing, especially as we get older.</p> <p>When a corporation or government (the two most common issuers of bonds) sells you a bond, it promises to repay the money at a specified future date (known as the bond's &quot;maturity date&quot;). Along the way, it also promises to pay you a fixed interest rate at regular intervals.</p> <p>Bond issuers use the tool to raise money for their operations. For example, when a local government needs to put in a new $3 million sewer system, it might sell $3 million worth of bonds to pay for the pipes. In essence, it's a way for them to borrow money, possibly for a longer time frame and at a lower interest rate than would be available to them through other means.</p> <p>You, as a buyer of the bonds, get a fairly safe investment with a known interest rate that is typically higher than you could get through <a href="http://www.wisebread.com/12-places-to-keep-your-money-safe-and-growing">other low-risk investments</a>, such as CDs.</p> <h2>2. Bonds Are Relatively Safe</h2> <p>If you read past Shakespeare's more famous phrase, you'll find this warning, &quot;&hellip;For loan oft loses both itself and friend.&quot;</p> <p>As safe as they may be, bonds do come with a risk of financial loss. The two main risks are credit risk and interest rate risk.</p> <h3>Credit Risk</h3> <p>A bond issuer's promise to repay is only as good as the issuer's financial strength. U.S. government bonds are safe as can be. If our country gets in financial trouble, it can just print more money. A start-up company's bonds? Not nearly as safe.</p> <p>If the issuer of the bond you bought goes out of business, you'll be out the money. That's what's meant by credit risk. You can manage this risk by buying highly rated bonds. Two companies rate the financial strength of bond issuers: Moody's, and Standard and Poor's. Bonds from the most credit-worthy organizations carry a AAA rating. Those with the worst ratings carry a C rating. The better the rating, the safer the bond. The downside is that the interest paid by the safest bonds is typically less than that paid by the lowest rated bonds.</p> <h3>Interest Rate Risk</h3> <p>The other type of risk associated with bonds is interest rate risk. When interest rates rise, the value of an already-issued bond falls. Think of it this way: If newly available bonds are offering a higher interest rate than your bond, why would someone buy yours? You'll have to offer it for less than you paid for it in order to attract a buyer. Of course, for buyers of individual bonds, this only matters if you plan to sell the bond before it matures. Otherwise, you'll still get back what you paid for your bond when it matures as well as the promised interest.</p> <h2>3. Bonds Exist to Lower the Risk of Your Portfolio</h2> <p>One of the most important principles in successful investing is <em>asset allocation</em>. This refers to how you divide your investment dollars across different asset classes, and the two most important asset classes are stocks and bonds. Stocks tend to be riskier than bonds, and over time they tend to generate better returns. When you're young, you have time to ride out the market's ups and downs, so an all- or mostly-stock portfolio is usually the way to go. As long as you can handle the ride, it will typically generate a better long-term return than a more conservative portfolio. (See also: <a href="http://www.wisebread.com/2-investing-concepts-everyone-should-know?ref=seealso">2 Investing Concepts Everyone Should Know</a>)</p> <p>As we get older, we can't afford to take as much risk, so it's best to reduce the amount of stocks in our portfolio, replacing them with lower-risk investments, such as bonds. Bonds are designed to lower the risk of your portfolio, smoothing out the ups and downs. The trade-off is they will also typically lower your overall returns.</p> <h2>4. The Easiest Way to Buy Bonds Is Through a Bond Fund</h2> <p>You can buy individual bonds, but it takes time to research the best ones and build an adequately diversified bond position in your portfolio. A much easier way is to buy bond mutual funds. Such funds are inherently diversified.</p> <p>All of the major fund companies offer bond funds, and you'll find many different types to choose from. There are corporate and government bonds; short-term, intermediate-term, and long-term bonds; domestic and foreign bonds, and more.</p> <p>You can also buy funds that contain a mix of stocks and bonds, such as target-date funds, which have become a common and popular option in 401(k) and other workplace plans. Such funds come with preset stock/bond allocations, based on how long an investor has until he or she plans to retire.</p> <p>They also automatically change that allocation over time, shifting away from stocks and toward bonds as the investor gets older. Target-date funds are far from perfect, but they do offer one of the easier ways to manage the use of bonds in your portfolio.</p> <h2>5. Boring Can Be Beautiful</h2> <p>Some people think of bonds as boring, and owning bonds certainly isn't as exciting as owning Tesla stock. But the older we get, the more the steady, low-risk income produced by the bonds become a thing of beauty.</p> <p><em>Do you own bonds? Why or why not?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/matt-bell">Matt Bell</a> of <a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/your-401k-in-2017-heres-whats-new-for-you">Your 401K in 2017: Here&#039;s What&#039;s New for You</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/your-401-k-is-not-an-investment">Your 401(k) is not an investment</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/10-stocks-and-bonds-that-will-profit-from-the-fed-rate-hike">10 Stocks and Bonds That Will Profit From the Fed Rate Hike</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/what-you-need-to-know-about-the-easiest-way-to-save-for-retirement">What You Need to Know About the Easiest Way to Save for Retirement</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation bond fund bonds investing stocks Thu, 05 Mar 2015 14:00:07 +0000 Matt Bell 1317214 at http://www.wisebread.com One Simple Trick to Get the Best Tax Benefit From Your Retirement Portfolio http://www.wisebread.com/one-simple-trick-to-get-the-best-tax-benefit-from-your-retirement-portfolio <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/one-simple-trick-to-get-the-best-tax-benefit-from-your-retirement-portfolio" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/balance-5121079-small.jpg" alt="balance" title="balance" class="imagecache imagecache-250w" width="250" height="141" /></a> </div> </div> </div> <p>The most basic strategy for long-term investing is asset allocation. But keeping to an allocation means rebalancing your portfolio, and rebalancing is fraught with complications &mdash; one big one being the tax implications of the sales you need to make. A simple trick can help you deal with that issue, but first let&#39;s take a closer look at asset allocation and rebalancing. (See also: <a href="http://www.wisebread.com/best-asset-allocation-for-your-portfolio">The Best Asset Allocation for Your Portfolio</a>)</p> <h2>What Is Asset Allocation?</h2> <p>The idea of asset allocation is to spread your investments among various categories (stocks, bonds, cash, gold, real estate, etc.), with the percentages in each category chosen to balance your desire for return and willingness to take risk.</p> <p>There are a lot of rules of thumb for asset allocation.</p> <h3>Spreading Your Wealth Around</h3> <p>One simple one is to set the stock fraction of your portfolio equal to 100 minus your age &mdash; so a 24-year-old would go with a portfolio of 76% stocks with the rest in bonds. Each year the portfolio gets a little more conservative, gradually shifting to only 35% stocks by age 65.</p> <p>An asset allocation championed by financial writer Harry Browne was a simple 25% each divided among stocks, bonds, gold, and cash.</p> <p>Many financial writers and advisors have model asset allocations. There is, of course, no way to know what asset allocation will turn out to be the best (until the future arrives, and it turns out that an asset allocation of 100% in whatever went up the most would have been best).</p> <p>My own sense is that any reasonably well-diversified portfolio will be okay: Just pick one. Sticking to an asset allocation means that you automatically avoid the error of putting all your money into whatever last year&#39;s hot investment was. (See also: <a href="http://www.wisebread.com/4-quick-ways-to-decide-if-a-company-is-worth-your-investment?ref=seealso">How to Know if a Company Is Worth Your Investment</a>)</p> <h2>What Is Rebalancing?</h2> <p>Because investment prices are constantly changing, your portfolio will almost immediately be out of balance. If stocks have gone up, the percentage of your portfolio invested in stocks will be above the target level. Rebalancing is the process of getting each category of your portfolio back to its target percentage. (See also: <a href="http://www.wisebread.com/keep-an-eye-on-your-money-with-these-7-online-investing-tools-and-apps?ref=seealso">7 Online Investing Tools and Apps</a>)</p> <p>In theory, rebalancing is easy:</p> <ol> <li>Calculate your total assets.<br /> &nbsp;</li> <li>Apply your target percentages to figure out how much money you should have in each category.<br /> &nbsp;</li> <li>In any category that&#39;s over its allocation, sell enough to bring the category down to the target.<br /> &nbsp;</li> <li>Use the money from those sales to buy the appropriate amount in each category that was under it&#39;s percentage.</li> </ol> <p>In practice, rebalancing is trickier than that, for several reasons.</p> <h2>Rebalancing Complications</h2> <p>The first issue with rebalancing is deciding how often to do it. You could do it every day &mdash; or even every second &mdash; selling a little of anything that had gone up a penny and buying whatever had gone down a penny, but that much churning would just add complexity and expense to no particular benefit. The general consensus is that annual rebalancing is about right, but you could make the case that doing it monthly or quarterly would be better.</p> <p>The second issue with rebalancing is procrastination. There&#39;s just natural inertia &mdash; it&#39;s one more thing to do, but one that doesn&#39;t have a real deadline, so it gets put off until later. (See also: <a href="http://www.wisebread.com/i-ll-finish-this-post-tomorrow-10-ways-to-stop-procrastinating?ref=seealso">10 Ways to Stop Procrastinating</a>)</p> <p>There&#39;s another factor, though, which is that after a year, your portfolio is probably pretty far off from its target percentages &mdash; but in what seems like a good way. You&#39;ll have more of your winners and less of your losers, and who doesn&#39;t want that? Selling your winners is always tough, and buying the laggards even tougher.</p> <p>Those are both real issues, but this post is about the third issue with rebalancing, which is taxes.</p> <h2>Tax-Efficiency in Rebalancing</h2> <p>Besides the issue of it just being tough to let your winners go, rebalancing also raises the issue of capital gains taxes. All those sales of winners incur tax liabilities. (Worse, since you&#39;re not selling the losers, you don&#39;t even have any losses to offset your gains.)</p> <h3>Rebalance Via Contributions Rather Than Sales</h3> <p>There&#39;s one basic trick to ameliorate this issue, which works pretty well: <em>Use your contributions to rebalance your portfolio.</em> Instead of dividing your contributions up the same as your target percentages, divide them up so as to move your portfolio closer toward balance.</p> <p>The calculations can get complicated if you let them &mdash; but you don&#39;t need to let them.</p> <p>If you make contributions frequently, and especially if a single contribution isn&#39;t big enough to bring your portfolio entirely back into balance, you can do it the easiest possible way: Figure out which category is the most dollars below its target, and put your whole contribution into that one category. Do the calculation afresh for the each contribution, and your portfolio will stay reasonably close to your desired asset allocation.</p> <p>The same thing can work when you leave the contribution phase of your life and move into the draw-down phase: Use your withdrawals to move your portfolio back into balance by selling from whatever category is the most dollars over its target.</p> <p>Rebalancing by targeting your contributions works very well, especially in the early phases of building your portfolio, when each month&#39;s contribution is large compared to the size of your total portfolio.</p> <p>After ten or twenty years, your portfolio (we very much hope) will be large compared to each month&#39;s contribution, and it will drift from your target asset allocation faster than targeting your contributions can bring it back in line. This is somewhat eased by the fact that you&#39;ll probably be able to make larger contributions as you progress along in your career, but eventually market volatility will almost certainly force you to going back to plan A: Sell things that have gone up and buy things that have gone down. But a careful application of rebalancing with your contributions will minimize the amount you have to sell &mdash; and thereby minimize the amount of capital gains taxes you incur. (<a href="http://www.wisebread.com/your-401-k-is-not-an-investment">Clever use of tax-advantaged accounts</a>, like IRAs and 401(k)s, will also help.)</p> <p><em>Do you look after your retirement funds via asset allocation? What tricks do you use to keep everything in balance?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/one-simple-trick-to-get-the-best-tax-benefit-from-your-retirement-portfolio">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-4"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/investment-gains-taxes-increase-the-worst-tax-policy-ever">Investment Gains Taxes Increase - The Worst Tax Policy Ever?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-highest-yielding-safe-investment-now-tax-exempt-money-market-funds">The Highest Yielding &quot;Safe&quot; Investment Now - Tax Exempt Money Market Funds</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-carried-interest-may-affect-our-taxes">How &quot;Carried Interest&quot; May Affect Our Taxes</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required">5 Ways to Invest Like a Pro — No Financial Adviser Required</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment Taxes asset allocation investment rebalancing retirement Wed, 08 Jan 2014 10:37:23 +0000 Philip Brewer 1107269 at http://www.wisebread.com Just Saving Isn't Enough: How Cash Flow Allocation Helps You Retire http://www.wisebread.com/just-saving-isnt-enough-how-cash-flow-allocation-helps-you-retire <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/just-saving-isnt-enough-how-cash-flow-allocation-helps-you-retire" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/cash-417690-small.jpg" alt="cash" title="cash" class="imagecache imagecache-250w" width="250" height="144" /></a> </div> </div> </div> <p>You&#39;ve probably heard the term &quot;asset allocation&quot; in discussions about retirement accounts and investing strategies. It&#39;s an important concept to understand and apply to your own finances. But don&#39;t be intimidated by the term or the complex definitions &mdash; the principle is a fairly simple one. (See also: <a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a>)</p> <p>At its heart, asset allocation is about reducing your risk by not putting all your eggs in one basket. And that&#39;s achieved by diversifying &mdash; or spreading out &mdash; the number and types of your investments.</p> <h2>Define &quot;Assets,&quot; Please</h2> <p>OK, but what assets are we talking about, and what&#39;s the &quot;cash flow&quot; connection?</p> <p>The assets typically associated with asset allocation are stocks, bonds, and cash equivalents such as money market funds. These are the ones commonly included in professionally managed mutual fund retirement accounts like a 401(k) or 403(b). So the thinking is, if you effectively diversify within and across each of these three asset categories, you will reduce your investment risk and achieve a balance that matches your risk tolerance.</p> <p>And you will&hellip;at least among those assets.</p> <p>But do these three assets alone make for a comprehensive retirement strategy? Nope.</p> <p>For one thing, there are many other types of assets besides stocks, bonds, and cash that can &mdash; and should &mdash; contribute to your retirement plan. Which ones? Here&#39;s where the cash flow connection comes in. (See also: <a href="http://www.wisebread.com/boost-your-retirement-savings-fast-with-this-6-step-plan">6-Step Plan to Boost Your Retirement Savings Fast</a>)</p> <h2>Will Your Assets Pay the Bills?</h2> <p>If you think about it, your mutual fund retirement account will generate only one income stream during your retirement. From a cash flow perspective this stock/bond/money market mix essentially represents only one egg. And as we now know, relying on only one source &mdash; in this case only one cash flow source &mdash; is a risky strategy. Better to allocate across multiple sources.</p> <p>To see this more clearly let&#39;s step back and look at the bigger picture. A good place to start is with a definition of your ultimate retirement goal. The goal for most is financial independence, and that&#39;s measured by monthly income or cash flow. You will need enough non-salary monthly cash flow to pay your living expenses in retirement. The more &mdash; and the more diverse &mdash; your sources of cash flow, the more secure will be your retirement. (See also: <a href="http://www.wisebread.com/7-essential-truths-for-a-successful-retirement">7 Truths for a Successful Retirement</a>)</p> <p>Your 401(k), 403(b), IRA, or mutual fund retirement account portfolio of stocks, bonds, and cash equivalents gives you a good start. After you stop working you can use these assets to generate monthly cash flow in a number of ways:</p> <ul> <li>You can convert it to an annuity that pays you monthly for life.<br /> &nbsp;</li> <li>You can convert it to a savings account or CD and draw down a certain percentage of the account balance on a regular basis until it&#39;s exhausted.<br /> &nbsp;</li> <li>Or, if your cash flow needs are mostly met by other assets, you can keep the principal intact and just draw from the stock dividends and bond interest income.</li> </ul> <h2>Other Cash Flow Generating Assets</h2> <p>What other assets generate cash flow?</p> <p><strong>Company Pension</strong></p> <p>This usually takes the form of a monthly payment for life, but in some cases companies offer the option of a single lump sum payout. Your &quot;lump sum to cash&quot; conversion options are similar to those listed above for a traditional retirement account.</p> <p><strong>Rental Income From Real Estate</strong></p> <p>Unlike a company pension, you own this asset and can sell it at any time for a lump sum amount. But if it provides a steady stream of positive cash flow, you might want to keep it &mdash; for it&#39;s that rare asset that appreciates in value AND whose monthly income (from rents) can also grow to keep pace with inflation. (See also: <a href="http://www.wisebread.com/should-you-become-a-landlord-instead-of-selling-your-home">Should You Become a Landlord?</a>)</p> <p><strong>Business Income</strong></p> <p>Owning a rental property is essentially like owning a business. So owning all or part of a business provides similar options: sell your stake for a lump sum or retain an ownership interest that can provide a regular income stream (plus the added bonus of possible tax advantages).</p> <p><strong>Social Security</strong></p> <p>Like a company pension, you don&#39;t own this asset; your only choice is a guaranteed lifetime stream of monthly cash flow.</p> <h2>Plan Ahead to Create Multiple Cash Flow Streams</h2> <p>Some of these cash flow sources might not be available to you. Traditional company pensions, for example, are becoming a thing of the past. But all of the others are under your control, and it&#39;s not too late to include some in your retirement plans.</p> <p><strong>Seven Streams Into Our House</strong></p> <p>Our household&#39;s retirement goal, for example, is to include seven cash flow sources. My wife and I were fortunate enough to work for employers who offered traditional defined benefit pension programs. They will represent those sources of monthly income. We also have a 401(k) and IRA retirement account portfolio (#3), positive cash flow from a rental property (#4), two future Social Security payments (#s 5 and 6), and a business (#7). &nbsp;</p> <p>Looking ahead, I&#39;d also like to buy or share in the ownership of another rental property, which would raise our number to eight. So our goal, like yours, should be flexible and open to change. The important part is to set a goal &mdash; set your cash flow number &mdash; so you can start making plans to achieve it.</p> <p>And remember &mdash; as you move ahead with your plans that having multiple cash flow-generating assets is preferable to relying on only one or two, because it diversifies or lessens your risk. You can more easily absorb the loss of one out of seven sources of retirement income than the loss of one out of two. So seek opportunities to earn or acquire multiple sources of positive cash flow.</p> <p>Yes, practice asset allocation; but also practice cash flow allocation.</p> <p><em>Have you considered cash flow allocation in your retirement planning? Will you?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/keith-whelan">Keith Whelan</a> of <a href="http://www.wisebread.com/just-saving-isnt-enough-how-cash-flow-allocation-helps-you-retire">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-5"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/why-one-third-of-americans-havent-saved-for-retirement">Why One-Third of Americans Haven&#039;t Saved for Retirement</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required">5 Ways to Invest Like a Pro — No Financial Adviser Required</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/7-retirement-planning-steps-late-starters-must-make">7 Retirement Planning Steps Late Starters Must Make</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-five-types-of-people-who-never-retire-are-you-one-of-them">The Five Types of People Who Never Retire (Are You One of Them?)</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/dont-know-what-annuities-are-you-might-be-missing-out">Don&#039;t Know What Annuities Are? You Might Be Missing Out</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Retirement asset allocation cash flow retirement retirement planning Tue, 22 Oct 2013 09:36:03 +0000 Keith Whelan 1028389 at http://www.wisebread.com The Basics of Asset Allocation http://www.wisebread.com/the-basics-of-asset-allocation <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/the-basics-of-asset-allocation" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/piggy-bank-5228342-small.jpg" alt="piggy bank" title="piggy bank" class="imagecache imagecache-250w" width="250" height="167" /></a> </div> </div> </div> <p>Whenever you talk to an investment professional, she invariably mentions the importance of <a href="http://www.investopedia.com/terms/a/assetallocation.asp">asset allocation</a>. Closely linked to the discussion of asset allocation is the concept of <a href="http://www.investopedia.com/terms/d/diversification.asp">diversification</a>. Both are considered useful in designing and managing an investment portfolio.</p> <p>Think of asset allocation as placing your proverbial eggs in three main categories of baskets: equities, fixed income, and cash equivalents. Refinement of asset allocation and diversification involves figuring out what types of baskets (such as large-cap blend and small-cap growth equities, technology and manufacturing sectors, etc.), and then choosing specific investments within those types. (See also: <a href="http://www.wisebread.com/a-guide-to-online-brokers-for-investing-newbies-and-beyond">A Guide to Online Brokers for Investing Newbies (and Beyond)</a>)</p> <h2>Rationale for Asset Allocation</h2> <p>Many professional advisers and websites will mention <a href="http://en.wikipedia.org/wiki/Modern_portfolio_theory">Modern Portfolio Theory</a> (or MPT) as the foundation of asset allocation. An idea crystallized and explained by <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1990/markowitz-bio.html">Harry Markowitz</a> (who won the 1990 Nobel Prize in Economics for his efforts), portfolio theory suggests that proper asset allocation is instrumental in optimizing portfolio return, given a specific risk tolerance.</p> <p>Others in the investment field simply promote the idea of allocating assets into various classes and diversifying within sub-classes or categories. This technique is useful for</p> <ol> <li>Managing risk and volatility.<br /> &nbsp;</li> <li>Capturing gains from the asset class along with the sub-class, sector, etc. that experiences growth during certain time periods.</li> </ol> <p>From what I can discern, the main difference between the two schools of thought is a nuanced one. Portfolio theory claims that proper asset allocation can optimize investment returns by locating the <a href="http://www.investopedia.com/terms/e/efficientfrontier.asp">efficient frontier</a> or <a href="http://oxforddictionaries.com/definition/english/sweet-spot">sweet spot</a> in an investment portfolio. Others indicate that you may need to sacrifice returns somewhat in order to minimize risk. Either way, asset allocation and diversification are employed to help investors reach their goals.</p> <p>The underlying assumption <a href="http://asset-allocation.net/modern-portfolio-theory-asset-allocation/">based on historical performance</a> is that different asset classes along with sub-classes, categories, and sectors perform better than others at any given time. For example, the prices of large-cap value stocks may grow at a rapid pace and small-cap growth stocks may falter under certain market conditions; however, small-cap growth mutual funds may soar when large-cap value funds decline.</p> <p>How different asset classes (and individual investments) move in relation to each other is known as <a href="http://asset-allocation.net/asset-class-correlation/">correlation</a>. If asset categories move in the same direction, they are positively correlated; in the opposite direction, negatively correlated. Asset allocation and diversification help manage this correlation so that fluctuations in investment returns stay within certain ranges based on risk tolerance. For an illustration of this concept, see the graph on <a href="http://www.schwab.com/public/schwab/resource_center/expert_insight/investing_strategies/portfolio_planning/the_portfolio_pyramid_how_to_diversify_your_investments.html">Model Asset Allocation Plans from Charles Schwab</a>.</p> <h2>Factors Affecting Asset Allocation Models</h2> <p>Most investment professionals and online investing tools create asset allocation models based on your risk tolerance and time horizon (or your current age). In general, stocks comprise a higher percentage of the overall recommended portfolio the higher your risk tolerance and the longer your time horizon. However, each model is designed slightly differently, so percentages assigned to asset classes vary. (See also: <a href="http://www.wisebread.com/using-time-horizons-to-make-smarter-investments">Using Time Horizons to Make Smarter Investments</a>)</p> <p>Your personal circumstances and economic conditions may lead you to alter a model asset allocation. For example, I feel comfortable investing more heavily in equities than generally recommended, so my ideal differs slightly from those proposed by asset allocation tools.</p> <p>Whatever your model, define and stick with its breakdown into various classes unless you have a compelling reason to change.</p> <h2>Using Asset Classes and More for Asset Allocation and Diversification</h2> <p>There are many sources, such as online tools as well as certified financial planners, that can provide guidance regarding asset allocation and diversification methods.</p> <p>Some offer general direction, specifying percentages for large-cap stocks, small-cap stocks, foreign stocks, bonds, and cash equivalents (such as this <a href="http://cgi.money.cnn.com/tools/assetallocwizard/assetallocwizard.html">tool from CNN Money</a>); whereas others give more detailed guidance. Note that this breakdown goes beyond main asset classes central to asset allocation and includes sub-classes, categories, sectors, etc. important for diversification.</p> <p>Portfolio analyzers often give comparisons of current holdings to target allocations based on risk tolerance. Also, there are diversification tools that help build and manage a portfolio alongside of asset-allocation illustrations. (See also: <a href="http://www.wisebread.com/5-best-online-brokerages">5 Best Online Brokerages</a>)</p> <p>Here are a few ways holdings may be classified and evaluated using portfolio analysis capabilities provided by these popular online brokerage firms:</p> <p><strong>TD Ameritrade</strong></p> <ul> <li> <p>Asset Allocation: Domestic Equity &mdash; Large Cap, Mid Cap, Small Cap, Other; International Equity &mdash; Developed, Emerging, Other; Specialty; Domestic Fixed Income; International Fixed Income</p> </li> </ul> <p><strong><a target="_blank" href="http://www.wisebread.com/redir/9812181">E*Trade</a></strong></p> <ul> <li>Asset Class: Stocks, Bonds, Cash<br /> &nbsp;</li> <li>Valuation: Value, Core, Growth<br /> &nbsp;</li> <li>Sector: Cyclical (Basic Materials, Consumer Cyclical, Financial Services, Real Estate); Defensive (Consumer Defensive, Healthcare, Utilities); Sensitive (Communication Services, Energy, Industrials, Technology)<br /> &nbsp;</li> <li>World Regions: U.S. &amp; Canada, Europe, Japan, Latin America, Asia &amp; Australia<br /> &nbsp;</li> <li>Stock Type: High Yield, Distressed, Hard Asset, Cyclical, Slow Growth, Classic Growth, Aggressive Growth, Speculative Growth</li> </ul> <h2>How to Use Portfolio Recommendations</h2> <p>Many portfolio management tools are comprised of three key components:</p> <ol> <li>Recommended allocations<br /> &nbsp;</li> <li>Current distribution among asset classes and categories<br /> &nbsp;</li> <li>Changes recommended because of differences between the ideal and existing asset mix</li> </ol> <p>High-level recommendations generated through online functionalities seem to be reasonable. For example, you may want to increase your holdings in international stocks and small-cap stocks if your portfolio is comprised mostly of large-cap stocks. Similarly, sector analyses may indicate ways you can diversify through greater concentration in utilities and healthcare and less in industrials, for example.</p> <p>However, more pointed recommendations, such as sell ABC stock or XYZ mutual fund and buy this one, tend to be less helpful. Take the suggestions as a starting point for further research rather than the ultimate answer about what you should do next with your portfolio.</p> <h2>Rebalancing</h2> <p>If your portfolio grows in the way that asset-allocation proponents predict (that is, certain asset classes grow and become over weighted when others languish or decline and become underweighted), then you'll need to <a href="http://investorsolutions.com/investment-strategy/portfolio-maintenance/is-your-portfolio-off-balance-2/">rebalance</a>. Review your current portfolio and make adjustments yearly or perhaps quarterly or whenever huge growth occurs and prompts the need to rebalance.</p> <p>To return your portfolio to its equilibrium, sell off the high-performing assets and increase your position in the other assets, or invest new money in the lower-performing assets. That is, buy more of what didn't perform well recently, so your portfolio will be positioned to capture gains in areas poised for growth. These rebalancing steps seem counterintuitive but are essential to maintaining your portfolio's asset allocation. (See also: <a href="http://www.wisebread.com/investment-allocation-by-age-birth-to-10-years-old">Investment Allocation by Age: Birth to 10 Years Old</a>)</p> <p>Asset allocation, diversification, correlation, and portfolio theory can get complicated. Financial professionals may oversimplify concepts (and occasionally draw misleading conclusions) for the purpose of championing thoughtful portfolio design as well as promoting an investment product and selling a service. Knowing the basic lingo of asset allocation can help you understand and participate in these conversations and make informed decisions for building and managing your portfolio.</p> <p><em>Have you employed asset allocation in managing your investments? Are you satisfied with the results?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/julie-rains">Julie Rains</a> of <a href="http://www.wisebread.com/the-basics-of-asset-allocation">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/tradeking-review-the-best-brokerage-for-new-and-intermediate-investors">TradeKing Review: The Best Brokerage for New and Intermediate Investors?</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/one-simple-trick-to-get-the-best-tax-benefit-from-your-retirement-portfolio">One Simple Trick to Get the Best Tax Benefit From Your Retirement Portfolio</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/a-lot-of-people-dont-understand-what-an-investment-really-is-do-you">A Lot of People Don&#039;t Understand What an Investment Really Is. Do You?</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-make-the-most-of-your-401K">How to Make the Most of Your 401K</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation investing investment online brokerage Tue, 13 Aug 2013 10:00:33 +0000 Julie Rains 981218 at http://www.wisebread.com 2 Investing Concepts Everyone Should Know http://www.wisebread.com/2-investing-concepts-everyone-should-know <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/2-investing-concepts-everyone-should-know" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/cash-5083256-small.jpg" alt="cash" title="cash" class="imagecache imagecache-250w" width="250" height="167" /></a> </div> </div> </div> <p>Investing is arguably the most complicated and intimidating topic within personal finance. Understanding (and making use of) two key investing concepts will go a long way toward demystifying the process while dialing down the fear factor. Let's get started! (See also: <a href="http://www.wisebread.com/the-10-step-staircase-to-a-comfortable-retirement" target="_blank">The 10-Step Staircase to a Comfortable Retirement</a>)</p> <h2>Compound Interest</h2> <p>At first glance, this one seems like no big deal. Compound interest is simply interest earning interest. For example, if you invest $100 and are able to earn 10% on that money, in a year it will have turned into $110. The next year, assuming you are still able to earn 10%, it isn&rsquo;t just the initial $100 that earns interest, but the interest you earned last year will earn interest as well. So, you won&rsquo;t end up with $120 at the end of year two; you&rsquo;ll end up with $121.</p> <p>Okay, so it&rsquo;s not that impressive. But wait. Let&rsquo;s put <a href="http://www.wisebread.com/book-review-the-little-book-of-big-dividends" target="_blank">more money to work and give it more time</a>.</p> <p>Imagine investing $200 per month for your <a href="http://www.wisebread.com/7-essential-truths-for-a-successful-retirement" target="_blank">retirement</a> beginning at age 20. And let&rsquo;s assume you can get a 7% return on that money. By age 30, you will have invested $24,000. That&rsquo;s $200 per month for 10 years. However, because of the 7% return, your $24,000 will actually be worth $34,617. Not bad, right? You racked up more than 10 grand in interest in just 10 years!</p> <p><strong>Don't Stop Believing</strong></p> <p>But wait. The longer you give it, the better it gets. Let&rsquo;s run this all the way out to age 70, which, let&rsquo;s face it, will probably be considered &quot;early retirement&quot; by then.</p> <p>The $200 you&rsquo;ve been dutifully tucking into your 401(k) plan all that time adds up to $120,000, an impressive amount unto itself. But because of the power of compound interest, that sizeable sum has become much, <em>much</em> more sizeable. In fact, it&rsquo;s now worth more than a million bucks. Now <em>that&rsquo;s</em> impressive. You&rsquo;ve earned about $970,000 in interest through the power of compound interest.</p> <p>This is why Albert Einstein reportedly called compound interest &quot;the eighth wonder of the world.&quot; Even if he didn&rsquo;t say that, it doesn&rsquo;t take a Nobel prize-winning scientist to understand that compound interest is a <em>relatively</em> powerful concept.</p> <p>Speaking of Einstein, there's a <a href="http://qrc.depaul.edu/StudyGuide2009/Notes/Savings%20Accounts/Compound%20Interest.htm" target="_blank">complicated looking formula</a> for calculating compound interest. It's actually pretty straightforward once you understand the terms.</p> <p>Even better, <a href="http://www.moneychimp.com/calculator/compound_interest_calculator.htm" target="_blank">here's an online tool</a> that calcualtes it for you.</p> <p>On a side note, this is exactly why it takes so long to get out of debt. Debt takes the strong wind of compound interest and flies it in your face. Keep the wind at your back by investing.</p> <p>&ldquo;Fair enough,&rdquo; you say, &ldquo;but where can I get a 7% return?&rdquo;</p> <h2>Asset Allocation</h2> <p>Pick up any personal finance magazine and you&rsquo;re likely to see breathless headlines about the latest mutual fund to rack up impressive returns. But you&rsquo;re not fooled. You realize that last month&rsquo;s hot performer might be tomorrow&rsquo;s dog. So which fund will do well <em>next </em>month?</p> <p>Surprisingly enough, generating a respectable return on your investments isn&rsquo;t so much about the specific investments you choose. It&rsquo;s how you spread your investment dollars around. This is known as asset allocation. It may have a boring name, but asset allocation has been found to account for about 90% of investment returns.</p> <p><strong>Choosing Between Stocks and Bonds</strong></p> <p>The key asset allocation decision is what percentage of your investment dollars to put in stocks and what percentage to devote to bonds (or stock-based and bond-based mutual funds). Stocks are riskier than bonds, but they have the potential to earn a higher return. In general, the younger you are, the more your investment mix should tilt toward stock-based investments, but your risk tolerance matters as well. You can find lots of <a href="http://www.smartmoney.com/calculator/investing/managing-asset-allocation-1304479164310/" target="_blank">free asset allocation calculators online</a>.</p> <p>The calculators will typically suggest something a bit more detailed than stocks vs. bonds; they may recommend that you devote different percentages of your money to large-cap stocks (the stocks of large companies), small-cap stocks, foreign stocks, and bonds. Most brokerage houses, such as Fidelity, Vanguard, Schwab, and others, offer index mutual funds in these categories, which can provide a low-cost, relatively simple way to invest in those categories.</p> <p>So, those are two key steps toward becoming a knowledgeable, successful investor. First, make use of the power of compound interest by getting started with investing as early as possible (although it&rsquo;s best to wait until you&rsquo;re out from under any <a href="http://www.wisebread.com/funding-your-401k-when-youre-in-debt" target="_blank">credit card or vehicle debt</a> and have a base of savings totaling three to six months&rsquo; worth of essential living expenses). And second, base your investment decisions on an intentional asset allocation plan that&rsquo;s tailored to your age and risk tolerance.</p> <p><em>What are your key investment concepts?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/matt-bell">Matt Bell</a> of <a href="http://www.wisebread.com/2-investing-concepts-everyone-should-know">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-3"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/best-asset-allocation-for-your-portfolio">Best asset allocation for your portfolio</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-false-allure-of-compound-interest">The False Allure of Compound Interest</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/this-one-thing-will-get-you-to-1-million-tax-free">This One Thing Will Get You to $1 Million (Tax-Free!)</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation compound interest investing Thu, 16 May 2013 10:36:31 +0000 Matt Bell 974061 at http://www.wisebread.com Asset Allocation for All Markets http://www.wisebread.com/asset-allocation-for-all-markets <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/asset-allocation-for-all-markets" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/asset allocation for all markets.jpg" alt="different piles" title="different piles" class="imagecache imagecache-250w" width="250" height="188" /></a> </div> </div> </div> <p class="MsoPlainText">Asset Allocation, being the distribution of your investment portfolio across different types of assets (known as “asset classes”), is not meant to be something that changes with the markets. In fact quite the opposite: a properly allocated portfolio is meant to weather both good markets and bad; to allow you to rest assured that your investments will reach your ultimate goals of what you need the money for without actively moving the money around. </p> <p class="MsoPlainText">The effects of proper asset allocation are not to be underestimated; the vast majority of your long-term returns are attributed to asset allocation – not market timing or selecting specific investments, as you might suspect. </p> <p class="MsoPlainText">But achieving the right asset allocation can be like groping around in the dark (and not in a fun kind of way!) if you don’t know where to begin. This article will help you to determine the proper asset allocation for your money. But first, some definitions of the different types of Asset Classes:</p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>Cash</strong></h3> <p class="MsoPlainText">Despite its name, this allocation is not a license to hide money under your pillow! Cash investments include <strong>high-interest savings and money market accounts</strong> – ones that won’t make you a ton of money, but that are guaranteed and that will likely keep pace with inflation. </p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>Fixed Income</strong></h3> <p class="MsoPlainText">These are mostly interest-bearing investments, and sometimes guaranteed (technically <em>“cash”</em> is a fixed income investment too). A fixed income investment won’t generally shoot the lights out in returns, but chances of investment losses are also capped. Examples are <strong>bonds, term deposits, and even some real estate derivatives</strong>. </p> <p>  <br /> <h3 class="MsoPlainText"><strong>Equities</strong></h3> <p class="MsoPlainText">Equities can be subdivided into <em>Domestic</em> and <em>International</em> categories. All equities are stock market investments, and of course not all stocks are created equal. This is where your financial planner (or a heck of a lot of research) will come in handy; differentiating the degrees of risk within an equity portfolio and reducing unnecessary risks. <strong>Although equities historically achieve the highest long term returns (by far) of any asset class, they will also see the most short-term fluctuation. </strong></p> <p class="MsoPlainText"><em>Large Cap</em> (short for market capitalization) or Blue Chip equities refer to large, stable companies that have a good history, long track record, and fairly steady returns. <em>Medium Cap</em> encompass smaller or newer companies but still widely recognized ones, and <em>Small Cap</em> investments will often be higher risk investments: start-ups or smaller companies in less popular market sectors. <strong>The more risk you assume, the higher your potential return will be – within reason. </strong></p> <p class="MsoPlainText">Domestic equities will generally be safer than International equities, because investing internationally subjects you to a new form of risk: <a href="/canadians-are-getting-fleeced-by-their-own-dollar" target="_blank">currency risk</a>. Your investment overseas may do gangbusters, but if your domestic dollar gains value comparatively in the meantime, you could actually see losses overall. </p> <p>  <br /> <h3 class="MsoPlainText"><strong>Sector</strong></h3> <p class="MsoPlainText">Sector investments refer to<strong> highly-specialized equities</strong>. They entail the highest amount of risk (along with potential for the highest gains), and should be limited in any portfolio. Examples of sectors include <em>Natural Resources or Science &amp; Technology</em>. </p> <p class="MsoPlainText">&nbsp;</p> <p class="MsoPlainText">&nbsp;</p> <p class="MsoPlainText">Now to <strong>determine your own personal asset allocation</strong> and how to diversify your portfolio across the above asset classes. Here are a few questions to ask that affect your portfolio’s asset allocation:</p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>What is Your Investment Time Frame?</strong></h3> <p class="MsoPlainText"><em>The shorter your time frame, the safer your portfolio needs to be</em>. The general rule is as follows:</p> <ul> <li>0-3 years = short term</li> <li>3-5 years = medium term</li> <li>6+ years<span>  </span>= long term</li> </ul> <p class="MsoPlainText">&nbsp;</p> <p class="MsoPlainText">You will now recognize that the asset allocation for a portfolio used to accumulate and save money for a major purchase (short term) will look different from a retirement portfolio (long term). Even those who are on the brink of retiring need to consider how long this portfolio needs to produce an income (count on 20-30 years), so don’t set your date of retirement as the date you cash everything out; you may be cheating yourself out of some much needed returns to keep pace with inflation over the duration of your retirement. </p> <p>  <br /> <h3 class="MsoPlainText"><strong>Do You Need an Income?</strong></h3> <p class="MsoPlainText">For somebody retiring as above, you may have a long investment time frame, but also the need to draw an income from the portfolio. <em>The more income you need (as a percentage of the entire portfolio), the more conservative a portfolio you should have</em>. </p> <p class="MsoPlainText">The next question to ask under this category is <strong>“how long will you draw down on the investment?”</strong> If you expect to deplete the fund in four years (as with a child’s post-secondary education portfolio), then your asset allocation should be more conservative than somebody looking for 30 years of income. </p> <p>  <br /> <h3 class="MsoPlainText"><strong>What is your Marginal Tax Rate? </strong></h3> <p class="MsoPlainText">Depending on how much income you earn, you may be looking to shelter some of the growth from taxation, or even convert highly taxable income (like interest income) to tax-efficient forms of income (like capital gains). Your marginal tax rate may determine how to invest money you don’t have a specific direction for, and may influence the specific choice of investments within your portfolio. </p> <p class="MsoPlainText">Also if you expect your income to change in the next few years, your asset allocation could be affected. Sheltering gains during years of high income and producing taxable investment income during lower-income years are all specialized asset allocation strategies. </p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>How Strong is Your Stomach?</strong></h3> <p class="MsoPlainText">This is probably one of the factors that will most influence your asset allocation choices, since you are the one who has to live with your investments. You may be young, saving for retirement, and showing all the technical signs of being a long-term aggressive investor, but<em> if you can’t handle the heat when the markets do loops, it’s not worth the heartache</em>. You will ultimately feel stressed out about money, will worry constantly, and will eventually bail – probably at the wrong time. </p> <p class="MsoPlainText">&nbsp;</p> <p> So how do these factors determine your investment mix? <strong>Here are six common types of investment personalities, and the recommended asset allocation for each. </strong><br /> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>Cash</strong></h3> <p class="MsoPlainText">You need the money within a very short period of time and cannot afford to lose a cent of it. You are likely accumulating for something like a down payment on a house, or some imminent purchases. </p> <p class="MsoPlainText">Allocation:<strong> 100% “cash”</strong></p> <p>  <br /> <h3 class="MsoPlainText"><strong>Conservative</strong></h3> <p class="MsoPlainText">You have a short investment time frame, and a low tolerance for investment fluctuation. You may need to draw a hefty income from the portfolio now, or shortly. Hopefully you are not in a high income tax bracket, because a conservative portfolio will generate mostly taxable income (unless it is in a special tax-sheltered account). </p> <p class="MsoPlainText">Average Allocation: <strong>15% Equities (all Domestic), 85% Fixed Income</strong></p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>Moderate Conservative</strong></h3> <p class="MsoPlainText">You either have a stronger stomach or a longer time frame than your conservative counterpart. You likely are still working within a short to medium time frame, but have the ability to expose a little more of your portfolio to fluctuation, with the hopes that you will achieve higher overall returns. </p> <p class="MsoPlainText">Average Allocation: <strong>25% Equities (of which up to 10% can be International), 75% Fixed Income</strong></p> <p class="MsoPlainText">&nbsp;</p> <h3 class="MsoPlainText"><strong>Moderate</strong></h3> <p class="MsoPlainText">A true fence-sitter with a medium time frame, and/or a middle-of-the-road tolerance for risk, you are the picture of balance between fixed income and equities. </p> <p class="MsoPlainText">Average Allocation: <strong>50% Equities (of which up to 25% can be International), 50% Fixed Income</strong></p> <p>  <br /> <h3 class="MsoPlainText"><strong>Moderate Aggressive</strong></h3> <p class="MsoPlainText">You likely have a long time frame and a good ability to ignore market fluctuations to achieve your long-term goals of good returns. You are interested in sheltering income from taxation, and your moderate aggressive portfolio is likely geared towards retirement. </p> <p class="MsoPlainText">Average Allocation: <strong>80% Equities (of which up to 40% can be International and up to 10% can be Sector), 20% Fixed Income</strong></p> <p>  <br /> <h3 class="MsoPlainText"><strong>Aggressive</strong></h3> <p class="MsoPlainText">You are ready to hang it all out there, and in market scenarios (like the present) when news of the sky falling is rampant, you are cool as a cucumber. In fact, you are probably investing even more money right now (which is the perfect thing to do). You are interested in tax shelters, are young, and certainly have a long time frame to ride out the bumps. </p> <p class="MsoPlainText">Average Allocation: <strong>100% Equities (of which up to 50% can be International and up to 15% can be Sector)</strong></p> <p class="MsoPlainText">&nbsp;</p> <p class="MsoPlainText">&nbsp;</p> <p> <span style="font-size: 10pt; font-family: 'Courier New'"><strong>It doesn’t matter what stage of your life you are in: asset allocation applies to you!</strong> If you don’t have a portfolio to speak of and are looking at saving money each month, that doesn’t mean you don’t deserve to have a properly allocated portfolio: simply start now. There are lots of <a href="/mutual-funds-for-wise-bloggers" target="_blank">managed funds</a> out there that will cater to your specific investment personality and will take care of the asset allocation for you within the fund. All you have to do is worry about saving the money; your solid asset allocation plan and the investment managers will take care of the rest. </span></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/nora-dunn">Nora Dunn</a> of <a href="http://www.wisebread.com/asset-allocation-for-all-markets">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-4"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/9-safe-investments-that-arent-bonds">9 Safe Investments That Aren&#039;t Bonds</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-ways-to-invest-like-a-pro-no-financial-adviser-required">5 Ways to Invest Like a Pro — No Financial Adviser Required</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash">How One Mediocre Investor Prospered After the Market Crash</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation cash equity fixed income investment portfolio investment returns managed funds market fluctuation risk reward Sun, 19 Oct 2008 11:09:02 +0000 Nora Dunn 2531 at http://www.wisebread.com Not free to be poor http://www.wisebread.com/not-free-to-be-poor <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/not-free-to-be-poor" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/bench-in-herb-garden-2.jpg" alt="Bench in herb garden" title="Bench in Herb Garden" class="imagecache imagecache-250w" width="250" height="233" /></a> </div> </div> </div> <p>Nobody wants to be poor.  It&#39;s a <a href="/voluntary-simplicity-versus-poverty">dangerous and constrained position</a> to be in.  But there are people out there (me, for instance) who are relatively happy to live at a fairly low standard of living.  Choosing to live at a low standard of living means you don&#39;t need to earn as much money--which opens up a huge range of possibilities that ordinary people don&#39;t have.  The way society is organized now, though, that&#39;s not a safe option.</p> <p>The classic early retirement strategy is simple to describe:  Earn a good salary, live frugally, save (and invest) the difference.  If you want to retire very early, you need a pretty big gap between what you earn and what you spend.  You also need to know how little you can afford to live on.  To those ends, living frugally is a double-win:  It frees up money to save and invest, plus it also acts as a &quot;proof of concept&quot; for your standard of living in retirement.</p> <p>(When you&#39;re unhappy with your job, it&#39;s easy to look at your spending and think to yourself, &quot;You know, if I didn&#39;t have to go to work every day, I wouldn&#39;t need to spend so much on X&quot; (where X can be just about anything from booze to vacations to video games).  While there&#39;s some truth to that, most people are smart enough to know that the thing to do is to cut your budget <strong>first</strong>.  It would suck to retire early and then discover that you&#39;re miserable without your X, whether it&#39;s a country club membership or a daily frufru coffee drink.)</p> <p>As I say, simple to describe.  It&#39;s even pretty simple to do, as long as you&#39;re willing to live below your means.  The problem, especially for Americans, is that it isn&#39;t safe.</p> <p>Suppose you do this.  Suppose you get a small, cheap apartment that&#39;s within walking distance of most of the places you need to go.  You quit driving much, parking (or even selling) your car.  You shop your closet for clothing, let your wardrobe dwindle, and only buy versatile, classic items that are made to last.  You eat a frugal diet with lots of in-season veggies and little or no meat.  You forgo new gadgets and toys, and you seek out cheap entertainment such as free concerts, museums, and libraries.</p> <p>Suppose, through such means, you get your expenses down to the point that you can <a href="/how-much-do-i-need-to-retire-how-much-can-i-spend">fund your lifestyle</a> entirely from your investment return.  (Short of that, maybe your investment return can fund a large enough portion of your living expenses that you can choose any sort of work that appeals to you, even if the pay is very low.)</p> <p>Are you now free to retire?  No.  At least, not if you live in the United States.  You have too many huge contingent expenses.</p> <p>A few of these can be dealt with through careful planning.  You can estimate how much you&#39;ll need to buy a new car every so often.  You can estimate how much you&#39;re going to have to spend to put your kids through college.  You can estimate what you&#39;ll need to cover an occasional new roof, furnace, air conditioner, window, door, hot water heater, and so on (generally not an issue if you rent).  But even if you have savings to cover these items, there are some contingent expenses that are simply unknowable.  In particular, you might get sick or injured, and find yourself bankrupted by medical bills.  </p> <p>Huge <a href="/things-to-insure-things-not-to-insure">contingent expenses</a> are exactly what insurance is for, and it works pretty well for protecting you against the loss of your home in a fire or of your car in a collision.  But, at least in the United States, it doesn&#39;t work worth crap for health insurance.</p> <p>Health insurance in the US is not only expensive, it&#39;s also uncertain.  Even if you can afford it, if you&#39;ve ever been seriously ill, there&#39;s a pretty good chance that no one will sell it to you at any price.</p> <p>There are other contingencies that the potential early retiree needs to worry about--investment losses, for example, or soaring prices for basic necessities like food--but they&#39;re relatively straightforward to deal with.  Having more than than the absolute minimum to cover your frugal lifestyle is wise.  A <a href="/best-asset-allocation-for-your-portfolio">well-diversified investment portfolio</a> that includes some foreign stocks, some bonds, maybe some real estate and precious metals can be expected to hold up pretty well.  A fraction of your retirement income should be in the form of an annuity (such as a pension), and a fraction should be inflation-protected (such as <a href="/tips-and-i-bonds">TIPS or I-Bonds</a>).  A willingness to do some sort of paid work (to only semi-retire, as it were) adds to your options as well.</p> <p>Sadly, none of these really solves the problem of medical insurance.  (Well, bumping your investment portfolio up by a few million dollars would be a partial solution, in the sense that most health insurance has a maximum payout of a few million dollars anyway, so with enough cash, you could just carry that risk yourself.  But that&#39;s just a further example of the fundamental problem that there&#39;s no ceiling on your potential liability.)</p> <p>I think everyone suffers as a result of the way we do health care in the United States.  How many people are working at jobs they don&#39;t like, or staying married to people they don&#39;t love, simply to keep their health insurance?  What if those people were unleashed to follow their bliss?  Everyone would be better off--them, their children, the people they&#39;re (unhappily) working for, the people they&#39;re (unhappily) married to, the people who could appreciate whatever they might be creating, if they weren&#39;t stuck in some job they no longer enjoy.</p> <p>I&#39;m looking forward to the day when society is organized such that I can pick a standard of living, arrange to earn that much money, and feel confident that ordinary bad luck won&#39;t ruin my life.  I want to be free to be poor.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/not-free-to-be-poor">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-5"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/health-care-reform-good-for-people-like-me">Health Care Reform: Good for People Like Me</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/6-ways-millennials-have-changed-money-so-far">6 Ways Millennials Have Changed Money (So Far)</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/37-ways-youd-be-better-off-as-a-bum">37 Ways You’d be Better Off as a Bum</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/its-the-21st-century-why-is-your-money-stuck-in-the-20th">It&#039;s the 21st Century — Why Is Your Money Stuck in the 20th?</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/book-review-the-only-investment-guide-youll-ever-need">Book review: The Only Investment Guide You&#039;ll Ever Need</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance Insurance Lifestyle asset allocation health insurance investing medical insurance poverty voluntary simplicity Mon, 07 Jul 2008 21:25:48 +0000 Philip Brewer 2221 at http://www.wisebread.com Best asset allocation for your portfolio http://www.wisebread.com/best-asset-allocation-for-your-portfolio <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/best-asset-allocation-for-your-portfolio" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/eagle-on-monument.jpg" alt="Eagle sculpture on a civil-war monument" title="Eagle on Monument" class="imagecache imagecache-250w" width="250" height="338" /></a> </div> </div> </div> <p>This is the first Wise Bread post that I&#39;ve been afraid to write. </p> <p>I&#39;ve thought about it many times, but haven&#39;t even gotten as far as making notes until today, when I finally figured out why it was so tough: It&#39;s going to be wrong. Five years from now, there&#39;s going to be one investment that did better than any other. With the perspective of hindsight, no investment advice will look good compared to &quot;Put all your money into SubprimeHybridSmartphones.com&quot; (or <a href="/gold-as-an-investment">gold</a> or farmland or <a href="/tips-and-i-bonds">TIPS</a> or whatever it turns out to be).</p> <p>Of course, you don&#39;t know what that investment will turn out to be. (Guess wrong and put all your money into SolarOrganicBicycles.biz instead and you&#39;ll be sorry--except maybe <em>that&#39;ll</em> turn out to be the best investment over the next <em>ten</em> years. After all, something has to be.)</p> <p>The desire to come up with an ideal asset allocation is a strong one. Investing magazines are always making up asset allocations after-the-fact and telling you about three funds that doubled or ten stocks that tripled last year--a useless activity that anyone with an internet connection could do. What we want is the right asset allocation for <em>next</em> year, a want that will not be satisfied, except occasionally by luck. </p> <p>Given that we don&#39;t know the future, what guidelines can we use to make our investment decisions?</p> <h2>Get your financial house in order</h2> <p>Before you do any serious investing, make sure you&#39;ve got:</p> <ol> <li>Your debts paid off (with the possible exception of mortgages and student loans, if they&#39;re at low, fixed rates)</li> <li>An emergency fund (with 3-6 months living expenses)</li> </ol> <h2>Think about your goals</h2> <p>I&#39;ve talked before about the <a href="/the-false-goal-of-maximizing-investment-returns">False goal of maximum investment return</a>. The purpose of your investment portfolio is to support your life goals. Obviously, to the extent that your goals can be satisfied with money, higher total returns gets your satisfaction earlier. But the fact is, many goals can&#39;t be satisfied with money, and for many of the others, <em>early</em> satisfaction isn&#39;t as important as <em>certain</em> satisfaction.</p> <p>The ideal asset allocation for someone who&#39;s saving up for a down payment on a house in three or four years is different from the allocation for someone who&#39;s saving to put their kid through college in 15 years, which is different from the allocation for someone saving for retirement in 30 years. (They&#39;re not completely different, though, especially if at least some of your goals are long-term ones.)</p> <p>Make a list of your financial goals, and come up with both a rough dollar figure and a target time range for each one.</p> <p>Except for very short-term goals (saving for a summer vacation or a new sofa), it&#39;s a mistake to create different accounts for different goals. What you want is one investment portfolio that supports all your goals.</p> <h2>Create your asset allocation</h2> <p>As long as the economy is ticking along, the stock portion of your investment portfolio is going to provide the bulk of the gains. Because of that, it makes sense to start with a theoretical 100% stock asset allocation, and then work backwards to account for all the reasons that you don&#39;t want all your money invested in stocks.</p> <h3>Considerations</h3> <p>First, the economy may not continue ticking along. Stocks entitle you to a share of the company&#39;s prosperity--and if the company doesn&#39;t prosper, that&#39;s not worth much. You want to have some investments that do well precisely when the economy is doing poorly--government bonds, for example.</p> <p>Second, most investments--stocks, bonds, bank accounts--even cash, when you get right down to it--are really <em>promises</em>. They&#39;re promises to pay some specific amount, promises to share (in the case of stocks), or the general promise to provide goods and services in exchange for money. Some of those sorts of promises tend to be kept (US government bonds, for example, have a great record). Others (just lately, subprime mortgage loans) haven&#39;t done as well. Sometimes the economy goes through extended periods during which promises aren&#39;t kept as well as usual. In those times, it&#39;s nice to own something that isn&#39;t a promise. The alternative to promises is <em>actual stuff</em>. Owning <a href="/huge-tax-free-investment-returns">stuff that you&#39;re going to use</a> is often an unbeatable investment. Once you&#39;ve stockpiled as much as makes sense, then you&#39;re talking about things like gold and silver. <em>Real estate</em> is an actual thing, although it&#39;s a special case for many reasons. It can be tempting to view companies that produce or own actual stuff as a special case as well, but remember that shares in such a company are still a promise. You want to own some amount of actual stuff, for times when promises aren&#39;t doing so well.<a href="/huge-tax-free-investment-returns" title="http://www.wisebread.com/huge-tax-free-investment-returns"><br /></a></p> <p>Third, many of your goals are not financial, and your portfolio ought to support those as well. For example, sleeping well at night is a goal for most of us, and many people find a portfolio whose value jumps around a lot bad for sleep. Putting some cash and some bonds into your portfolio helps with that. Living in a pleasant community is another goal, as is living in a just society, and allocating some of your investment portfolio to support local businesses, green businesses, and businesses who follow fair business practices can help there.</p> <p>Finally, although stock investments will likely get you to your goal sooner, <em>unlucky</em> stock investments might not get you there at all. Bonds, on the other hand, can almost certainly get you to your goal (although it may take your whole career).</p> <h3>Numbers</h3> <p>So, what does all that boil down to?</p> <p>A common rule-of-thumb used to be to subtract your age from 100 to get your stock allocation. So a 20-year-old would put 80% of the portfolio into stocks, while a 65-year-old would have only 35% stocks. The reason is that a 20-year-old can ride out even a long-term bear market. (In fact, a bear market that strikes just as your salary really starts to grow would be perfect, letting you you load up on cheap stocks for years.) Once you retire, though, a bear market is just a bad thing, so it&#39;s best not to have your whole investment portfolio exposed to stocks.</p> <p>Over the past 25 years, stocks have done so well that many advisors have been uping the stock percentage. Personally, I&#39;m reasonably happy with the old rule of thumb, at least for people of working age. I would be inclined to stop reducing the stock percentage when it hits about 35% and just hold it there through at least the first half of someone&#39;s retirement. </p> <p>So, what about the rest of your money? I&#39;d put a tidy chunk (half or more of the non-stock portion) into long-term government bonds. I&#39;d like to have some invested in <a href="/gold-as-an-investment">gold</a> and silver, but I wouldn&#39;t be inclined to buy much of either at current prices.</p> <p>After you&#39;ve funded your emergency account, there&#39;s only two good reason to hold cash in your investment portfolio:</p> <ol> <li>To support your near-term goals. As the time approaches to take that vacation or buy that sofa--or as the college-bound child goes to junior high and then to high school--make sure that you&#39;re shifting enough of your investment portfolio into cash to be able to write the checks. For things where the time horizon is very flexible, you can let the market dictate when you spend the money--I know one guy who repaved his driveway when our company stock hit an all-time high--but you don&#39;t want to find yourself trying to convince your daughter to put off getting married for a few years until the market recovers enough to fund the wedding.</li> <li>To take advantage of market opportunities. This is a good reason in theory, but it&#39;s hardly ever a good reason in practice. If you have enough cash on hand to really take advantage of a good opportunity, you&#39;re probably missing out on more market gains than your opportunity will provide. Just keep feeding your savings into your asset allocation you&#39;ve selected.</li> </ol> <p>Here&#39;s an example for a 40-year-old:</p> <ul> <li>60% stocks (half in an S&amp;P index fund, the rest divided between an international fund and a mid-cap fund)</li> <li>25% bonds (mostly long-term government bonds)</li> <li>10% stuff (stockpiled goods that you plan to use, then gold and silver)</li> <li>5% cash (percentage adjusted to support near-term goals)</li> </ul> <h2>Account for your illiquid holdings</h2> <p>Do you already own something that amounts to a major portion of your net worth, but that you couldn&#39;t just sell by calling your broker? The two most common things that fall into this category are a <em>house</em> or a <em>business</em>, but there are plenty of other possibilities, such as a large loan to a friend or relative (that you actually expect to be repaid).</p> <p>Assign a value to the illiquid investment, and include it in your portfolio, in whatever category comes closest. For example, a business probably goes in the category with stock market investments. A house would go in a &quot;real estate&quot; category.</p> <p>The liquid portion of your investment portfolio should emphasize the investment categories that are most different from your illiquid assets. If most of your net worth is tied up in your house, you wouldn&#39;t want to have additional real estate investments. </p> <h2>Account for your debt</h2> <p>Debts that you owe are part of your investment portfolio too. They should be entered as a negative value in the appropriate part of your portfolio (bonds for mortgages and student loans, cash for credit card debt or merchant debt).</p> <p>That can be kind of a scary exercise. Suppose, for example, a guy has a conservative asset allocation like the one above, and then bought a house. After that, his asset allocation might look like this:</p> <ul> <li>60% stocks</li> <li>150% real estate</li> <li>-120% bonds (including the mortgage)</li> <li>10% stuff</li> <li>0% cash (drained to make the down payment)</li> </ul> <p>Clearly, this guy is over-invested in real estate and under-invested in bonds (a near universal situation for new homeowners). There&#39;s no easy way to bring things quickly back into balance. It would probably make sense to sell some stock to replenish the cash and to pay down the mortgage. The stock is likely to have a better long-term return than the house, though, so I wouldn&#39;t reduce the stock percentage a whole lot. Over the long term, paying off the mortgage will bring this portfolio back into balance.</p> <p>It&#39;s worth doing the arithmetic to see what your portfolio looks like with your debts and illiquid assets included. If the results scare you, that will provide a bit of extra incentive to make the necessary adjustments.</p> <h2>Put your investments somewhere</h2> <p>I&#39;ve written before about not confusing the investments and the <a href="/your-401-k-is-not-an-investment">compartments to hold the investments in</a>. I&#39;ve also talked about when to use and <a href="/when-not-to-put-money-in-your-401-k">when not to use certain compartments</a>. This article isn&#39;t about that. It&#39;s about allocating your investment dollars among the various investment options.</p> <p>It&#39;d be nice if we knew which investments would do best, but none of us know the future. Given that, the best you can do is invest in stocks for growth, bonds for the times when growth is hard to find, and stuff, for the days when promises like stocks and bonds aren&#39;t kept.</p> <p>Good luck. </p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/best-asset-allocation-for-your-portfolio">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-6"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-basics-of-asset-allocation">The Basics of Asset Allocation</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/2-investing-concepts-everyone-should-know">2 Investing Concepts Everyone Should Know</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/3-survival-instincts-that-harm-investors">3 Survival Instincts That Harm Investors</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/is-there-such-a-thing-as-risk-free-investing">Is There Such a Thing as Risk-Free Investing?</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation investing investments Wed, 07 Nov 2007 15:02:45 +0000 Philip Brewer 1370 at http://www.wisebread.com Your 401(k) is not an investment http://www.wisebread.com/your-401-k-is-not-an-investment <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/your-401-k-is-not-an-investment" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/compartments.jpg" alt="" title="" class="imagecache imagecache-250w" width="250" height="182" /></a> </div> </div> </div> <p>Your 401(k) is not an investment. Neither is your IRA. Those are <strong>legal compartments</strong> for holding investments. Your investments are the mutual funds, stocks, bonds, and so on that you&#39;ve bought. The compartments are where you keep your investments.</p> <p>The distinction makes a difference. When you decide where to invest your money--what investments to buy--you should ignore the compartments. Deciding what compartment to use for each individual investment should come later.</p> <h2>Asset allocation</h2> <p>Investment advisors use the term &quot;asset allocation&quot; to mean where your money goes. You can get a lot of advice on asset allocation from advisors, books, web pages, and so on. There&#39;s a general consensus nowadays that most people should invest heavily in stocks, especially early in their career, and then shift very gradually into bonds--probably keeping a good percentage in stocks even after retirement. There are people who disagree, though--see my review of <a href="/book-review-your-money-or-your-life">Your Money or Your Life</a> , for a view on putting your money into long-term treasury bonds.</p> <h2>Compartments</h2> <p>The compartments change how your ownership of the investment is treated legally. The most important distinction among the compartments (but not the only one) is the tax treatment. Both 401(k)s and IRAs let you invest money that you earn without paying taxes on it--that lets you put more of your money to work, and gives you a huge edge in getting started investing. Roth IRAs take after-tax money, but you don&#39;t need to pay any taxes on the gains you make inside the Roth. (All that is only true if you follow certain rules, mostly having to do with leaving the money in the compartment until you reach retirement.)</p> <h2>Putting them together</h2> <p>There&#39;s an inclination to match investments to compartments based on the goal of the compartment: People think of their 401(k) as being for retirement, so they want to put investments in it that are suitable for retirement--long-term, but reasonably safe. At the same time, they might have a brokerage account that&#39;s not a retirement asset, where they feel free to make short-term trades with the hope of a big killing. That&#39;s not the right way to look at compartments.</p> <p>You only have one asset allocation, and it covers all the compartments. Let&#39;s say (purely as an example, and not recommended for anyone in particular) that you decide that you should have 60% stocks, 30% bonds, and 10% cash. That&#39;s one decision. Having decided that, you then need to decide which compartments should hold those investments. That&#39;s a separate decision.</p> <h2>The compartment decision</h2> <p>The main reason to pick one compartment over another is for tax efficiency. As rules-of-thumb: </p> <ul> <li>Investments that produce <strong>interest income</strong> should go into a tax-deferred account such as a 401(k) or an IRA. Otherwise, you need to pay taxes on the income every year. </li> <li>Investments with <strong>frequent turnover</strong> should go into a tax deferred account. If you make trades in your ordinary brokerage account, you need to pay taxes on any profits you make every year. In a 401(k) or IRA, you can postpone all those taxes until you take the money out.</li> <li>Investments that produces<strong> long-term capital gains </strong>or<strong> dividend income</strong> should probably <strong>not</strong> be in a tax-deferred account. Capital gains and most dividends are taxed at a reduced rate. If they&#39;re earned in a tax-deferred account, though, all the money that you withdraw will be taxed as ordinary income when it is withdrawn, losing the investment&#39;s tax advantage.</li> </ul> <p>Of course, you&#39;re limited to the investments available in your 401(k). Fortunately, most 401(k)s offer a pretty good range of choices nowadays. Even if your 401(k) has only one or two good choices, though, you&#39;re still okay. Buy the best investments your 401(k) offers, then buy other investments outside your 401(k) to achieve your desired overall asset allocation.</p> <p>No individual compartment needs diversification--only your overall portfolio does. </p> <h2>Company match</h2> <p>Probably the most important factor for your medium-term investment success has nothing to do with your asset allocation or the tax issues of your compartment selection. It&#39;s your company match.</p> <p>If your employer offers a match on the money you put into your 401(k), you should almost certainly take it. Whether the match is 100 cents on the dollar or 50 cents on the dollar, it is still much more than you&#39;re likely to earn on any investment and much more than you&#39;re likely to be paying on your debts. As long as funding your 401(k) to the extent of getting the full employer match doesn&#39;t make you miss payments on your debts, you&#39;re probably better off funding the 401(k) even if it delays paying off credit cards. The match is that big. (If getting a 50% match meant delaying paying off a debt for, say, 3 years, you&#39;ll still come out ahead if the debt is at less than 16%.)</p> <h2>Protected compartments</h2> <p>One other advantage that most of these special compartments such as IRAs and 401(k)s have is that your funds within them are largely protected against being taken in a lawsuit or bankruptcy. No one is without risk of a lawsuit, so that&#39;s all the more reason to fully fund your 401(k) or IRA.</p> <p>Retirement accounts are not protected against <strong>all</strong> risks. A divorce court will likely take retirement assets into account when making a property settlement. The government may also be able invade them for things like tax debts and student loan debts. Against most other debts, though, your retirement accounts are safe. The rules for each different compartment are slightly different, which means it makes good sense to divide your money up a bit, just in case one particular compartment is vulnerable to one particular hazard.</p> <h2>Recap</h2> <p>Wise use of compartments can protect you from taxes and many other things. Just don&#39;t confuse the compartments with the investments they contain. </p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/your-401-k-is-not-an-investment">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-7"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/what-you-need-to-know-about-the-easiest-way-to-save-for-retirement">What You Need to Know About the Easiest Way to Save for Retirement</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash">How One Mediocre Investor Prospered After the Market Crash</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-most-important-thing-youre-probably-not-doing-with-your-portfolio">The Most Important Thing You&#039;re Probably Not Doing With Your Portfolio</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-3-rules-every-mediocre-investor-must-know">The 3 Rules Every Mediocre Investor Must Know</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment 401(k) asset allocation bonds IRAs stocks Wed, 15 Aug 2007 11:21:38 +0000 Philip Brewer 998 at http://www.wisebread.com