Balance Balance Balance

There is a famous Japanese story about a proud young champion archer who feels ready to challenge the most famous master archer in the land. He goes to the old man’s house, boasting of his skills. They walk outside. The young man points to a tree that is so distant the old man can hardly see it, “Watch me hit that tree.” And he hits it.

The wise old man picks up his bow and a quiver full of arrows saying, “Follow me.”

They climb the mountain outside of town until they reach a place where there is a deep gorge between two cliffs. A somewhat rotten looking log serves as a bridge from their side to the other side. The old man walks out on the log. Taking a arrow out of his quiver, he calmly draws back his bow, shooting the arrow into a nearby tree. As he returns to safety, he looks at the young man, “Let’s see if you can make that shot.”

The young man walks out on the creaking shaky log. Overcome with fear he can hardly draw back his bow. Naturally, he misses the tree altogether. The old man smiles, “Just keep practicing. You’ll get better.”

Balance is so important; in life; in finances. It is hard to maintain your balance when the winds start to blow and the log over the gorge begins to shake, but learning to maintain your focus will lead to mastery. An age appropriate balance of bonds and stocks is one of the keys to maintaining your investment portfolio through good times and bad.

Old Conventional Wisdom: Keep your age in bonds and cash.

Hence in my case, I would 63% in bonds and 37% in stocks.
For a thirty year old that would be 30% in bonds and 70% in stocks.

New Conventional Wisdom: Your Age Minus 15% in Bonds:

In my case, that would be 48% in bonds and 52% in stocks.
For a thirty year old investor, that would be 15% in bonds and 85% in stocks.

Breaking it down a little further, I would note that the thirty year old couple should be primarily building their cash position in a six month emergency fund. It is unlikely that they have achieved that goal with so much going on in their lives. I believe in retirement, I should hold about 10% of my liquid net worth (excluding the value of my primary residence) in cash. This includes money in checking accounts, savings accounts, and money market accounts.

I can not predict the future. I didn’t know when the stock market would hit bottom. I don’t know when the current bull run will end. However, I do know that we are now closer to a top in April 2013 than we were in April of 2009. Therefore I have a little more money in cash and bonds than is usual. When nearing a bottom I will, hopefully, have more money in stocks than in cash and bonds.

I believe an age appropriate range for someone of my age, 63, should fall between 40% and 55% of my net worth excluding my primary residence in stocks and stock mutual funds. If my holdings fall outside of this range, it is time to rebalance.

Even before you have any money to invest balance is important in setting up a budget. Different teachers suggest different target allocations. This one is from Kiplinger’s, “Use 30% of your take-home pay for housing, 10% for utilities, 15% for food, 10% for transportation, 5% for clothing, 10% for debt repayment, 5% for entertainment and 5% for insurance and miscellaneous expenses. That leaves 10% for savings or special purchases.”

It might be wise to record all your expenses, all of them--to the penny--without exception, for a month before actually setting up your first budget. If you do this exercise, you will discover that there are discrepancies between your spending patterns and reality. You will also discover that your spending patterns do not reflect your values or priorities. If you want to save for a down payment on a home, you may not want to spend 10% of your take home pay in bars and restaurants.

Maintaining your balance out there on the budget tightrope requires the flexibility to respond to unexpected wind gusts. There are several tools that will help. First, you can reallocate money from the “blow” category to cover an unexpected expense, like a car repair. If that isn’t enough, you can move money from the clothing line to the car maintenance line to cover the shortfall. Finally, if all else fails use the emergency fund. That is why you have an emergency fund.

Don’t make a budget too complicated. Have enough lines to cover what is necessary for you to see. For example, if you buy your cleaning supplies at the grocery store just budget for those expenses and record those expenses on the “food” line. If there are other expenses that are incurred at the grocery store that you want to control as a separate line item, such as beer or cigarettes, pull them out of the register total. Don’t worry about where the sales tax on these items lands.

Listen to the old master’s advice to the young champion, “Just keep practicing. You’ll get better.” Don’t give up if you miss the target. Some shots look easy, but when it is you out there on that log 500 feet above a rocky mountain river, things get a lot harder.

Even the great Michelangelo observed, “If people knew how hard I worked to get my mastery, it wouldn’t seem so wonderful at all.”