Asset Allocation (Part I)

The old conventional wisdom stated that an individual investor should hold his age in bonds, certificates of deposit, and cash. Hence, at 59 I should have 59% in fixed income investments and 41% in stocks. The new conventional wisdom states that these figures are too conservative given the risk of inflation. The new rule of thumb states that the individual investor should have either 110 or 115 minus their age in stocks. Hence, I should be holding 51% or 56% in stocks at any given time.

There are lots of ways to look at the problem of asset allocation. This would not be a problem if we could see into the future with perfect accuracy. However, I am not a psychic. I am asked this question from time to time. There is no right answer. Just find a proven investment method that is comfortable for you, keep working on your investment portfolio in a systematic and disciplined manner, don’t let your actions be ruled by your emotions, and trust in the Lord with all your heart.

On the first of every month I look at my asset allocation and see if it makes sense to me. If it doesn’t, I make a few adjustments. On March 1, 2010 my assets were distributed as follows:

Stocks excluding gold and silver----------44.8%
Bonds and Certificates of deposit---------33.9%
Cash (Money market accounts)--------------17.9%
Gold and Silver--------------------------- 3.4%

That is the way I approach this problem.

To put things into context, I consider gold and silver just another but a different kind of stock and add the two numbers together when comparing my stock holdings to the conventional wisdom. When the market is dropping I continue to buy small amounts of stock on the way down. When the market heads back up I take small amounts of my winnings and move them into bonds. In late October I was holding about 55.7% (from memory) in stocks and gold. I thought then and still believe that the market is overvalued given the high levels of unemployment in this country. Since then, over time, I have been moving small amounts into the two bond funds in my retirement account. On March 1, 2010 I was holding 48.2% in stocks and gold. Since then the market has continued to climb. Because my money is divided, the total is increasing and the percentage I am holding in stocks is increasing.

On April 1, I will once again consider my options.

Schwab classifies my risk tolerance (based on my behavior over the last 8 or 9 years) as “Moderately Conservative.” Actually, I fit into three risk tolerance models at the same time, Conservative, Moderately Conservative, and Moderate. Here is how those model portfolios break out.

Conservative

15% Large Cap Equity
0% Small Cap Equity
5% International Equity
50% Fixed Income
30% Cash or Equivalent

Moderately Conservative

25% Large Cap Equity
5% Small Cap Equity
10% International Equity
50% Fixed Income
10% Cash or Equivalent

Moderate

35% Large Cap Equity
10% Small Cap Equity
15% International Equity
35% Fixed Income
5% Cash or Equivalent

Given the reporting methods between my retirement account at work and my self directed account differ I can’t give you a completely accurate breakdown using this model. However, I can give you a pretty good estimate.

My Current Risk Profile

27% Large Cap Equity
8% Small Cap Equity
13% International Equity
34% Fixed Income
18% Cash or Equivalent

You will notice that Schwab does not call out precious metals as a discreet category. Given the behavior of our Government, I believe this is a mistake. Almost every portfolio would benefit from a little gold. How much? Who can say? I just can't get my crystal ball to tell me anything of value.

I believe that our economy is decreasing as a percentage of the world’s economy. I believe the developing economies of countries like Brazil, China, India, Singapore, and Russia are going to become more important. I believe the amount I hold in International Equity is too small. I would buy more today, but I believe the market is over valued. Currently, my holdings are in resource rich Canada and England (with exposure to China). These economies are really not any more risky than our economy.

I am a little on the high side in Small Cap stocks, but my Small Cap stocks typically pay a dividend and are not all that risky. I believe Small Cap Value stocks that pay a dividend are pretty good investments.

I am holding more cash than recommended for a variety of reasons.

1) My car is old and may need replacement
2) One of our bathrooms needs to be gutted and rebuilt
3) I am both a coaster and a squirrel (remember Jordan Goodman’s money types)
4) A combination of fear and sloth

I should have more money in either Certificates of Deposit or an Investment Grade Short Term Bond Fund.

What is right for you? Kind of depends, on your age, on your tolerance for risk, and on your future potential earnings picture. I have given you a snapshot of what I am trying to accomplish. So far it is working pretty well. The hardest part of any investment program is controlling your emotions and remaining a systematic, disciplined saver and investor. Savings is really important and the first step in any investment program. Systematic savings will also allow you to rebuild your reserves after an economic debacle.

Maybe I will look at sector allocation on another day. Because I favor “real stuff” like oil, gold, land, consumer staples, and regulated utilities, I have had a little trouble with a tendency to let my sector allocation get out of balance. I was holding too much gas and oil when the price of those commodities collapsed with demand in the summer of 2008.

Solomon said it best.

Ecclesiastes

[1] Cast thy bread upon the waters: for thou shalt find it after many days.
[2] Give a portion to seven, and also to eight; for thou knowest not what evil shall be upon the earth.
[3] If the clouds be full of rain, they empty themselves upon the earth: and if the tree fall toward the south, or toward the north, in the place where the tree falleth, there it shall be.
[4] He that observeth the wind shall not sow; and he that regardeth the clouds shall not reap.
[5] As thou knowest not what is the way of the spirit, nor how the bones do grow in the womb of her that is with child: even so thou knowest not the works of God who maketh all.
[6] In the morning sow thy seed, and in the evening withhold not thine hand: for thou knowest not whether shall prosper, either this or that, or whether they both shall be alike good.