Asset Allocation

Posted by Don on March 21, 2009

If you have read any of my posts I have been asking that people use rallys to sell some of their 401K positions and add cash.  I had a comment asking me how much cash they should have and I had to think for a second.  You have always heard that you need to be comfortable with how much money you had invested in stocks depending on your risk appetite.  You have heard things thrown around like 80% stocks and 20% bonds, etc.

Well I went out and found a data from Robert Shiller’s book “Irrational Exuberance” from 2005 with 10 year treasury bond rates and S&P 500 numbers and dividends going back to 1971.  Thanks to the miracle of compounding and reinvesting dividends there isn’t much comparison.  From 1871 to 2008 you would have the following average returns.  For stocks this includes dividends reinvested and interest reinvested for the bonds and the portfolio is reallocated at the beginning of every year to ensure the allocation is correct.  Nothing has been removed for commissions or fees.

 100% stocks                80% stocks / 20% bonds         60% stocks/ 40% bonds

    10.08%                                         8.97%                                              7.90%

Now this is average over 137 years, but as you can see there is virtually a 1% compounding difference for every 20% you allocate to bonds.  Now using the historical averages which includes The Great Depression and both World Wars this covers great times and bad times.  The question remains how much of your funds should you allocate to stocks and how much to bonds? 

 The answer is the same as above, it depends upon how much risk you feel comfortable taking.  If you feel comfortable with all of your funds in stocks then you can expect a 10% return on average with dividends reinvested.  There is no perfect allocation for every person, and any funds you put in the stock market should have a time horizon of over 5 years.  Just be aware that for a reduced percent in stocks you will have to accept a reduced return over a longer time horizon.     

 Now you could choose to take a more active role in your investments and learn technical analysis that will allow you to reallocate your positions from what the prices of the markets are telling you.  As I said in Technical Analysis Part 1 Moving Average if you had used the 50 and 200 day moving average crossover buy and sell signals from September 1994 which gave a buy signal to February 2009 you would have an average annual return not including dividends of 18.6% as opposed to if you had bought and held you would have a return of 4% annually. 

 Take control of your investments and don’t stay with a manager who just buys and holds. 

 As always read the disclaimer I am not a licensed financial adviser and I only invest for myself.  Please consult a licensed financial advisor before investing.