Category Archives: Market Volatility

Financial Planning 12 Step Process

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A financial plan creates a roadmap for your money and helps you achieve your financial goals.

The purpose of financial planning is to help you achieve short- and long-term financial goals like creating an emergency fund and achieving financial freedom, respectively. A financial plan is a customized roadmap to maximize your existing financial resources and ensures that adequate insurance and legal documents are in place to protect you and your family in case of a crisis. For example, you collect financial information and create short- and long-term priorities and goals in order to choose the most suitable investment solutions for those goals.

Although financial planning generally targets higher-net-worth clients, options also are available for economically vulnerable families. For example, the Foundation for Financial Planning connects over 15,000 volunteer planners with underserved clients to help struggling families take control of their financial lives free of charge.

Research has shown that a strong correlation exist between financial planning and wealth aggregation. People who plan their financial futures are more likely to accumulate wealth and invest in stocks or other high-return financial assets.

When you start financial planning, you usually begin with your life or financial priorities, goals or the problems you are trying to solve. Financial planning allows you to take a deep look at your financial wellbeing. It’s a bit like getting a comprehensive physical for your finances.

You will review some financial vital signs—key indicators of your financial health—and then take a careful look at key planning areas to make sure some common mistakes don’t trip you up.

Structure is the key to growth. Without a solid foundation — and a road map for the future — it’s easy to spin your wheels and float through life without making any headway. Good planning allows you to prioritize your time and measure the progress you’ve made.

That’s especially true for your finances. A financial plan is a document that helps you get a snapshot of your current financial position, helps you get a sense of where you are heading, and helps you track your monetary goals to measure your progress towards financial freedom. A good financial plan allows you to grow and improve your standing to focus on achieving your goals. As long as your plan is solid, your money can do the work for you.

A financial plan is a comprehensive roadmap of your current finances, your financial goals and the strategies you’ve established to achieve those goals. It is an ongoing process to help you make sensible decisions about money, and it starts with helping you articulate the things that are important to you. These can sometimes be aspirations or material things, but often they are about you achieving financial freedom and peace of mind.

Good financial planning should include details about your cash flow, net worth, debt, investments, insurance and any other elements of your financial life.

Financial planning is about three key things:

  • Determining where you stand financially,
  • Articulating your personal financial goals, and
  • Creating a comprehensive plan to reach those goals.
  • It’s that easy!

Creating a roadmap for your financial future is for everyone. Before you make any investing decision, sit down and take an honest look at your entire financial situation — especially if you’ve never made a financial plan before.

The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional.

There is no guarantee that you’ll make money from your investments. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money.

12 Steps to a DIY Financial Plan

It’s not the just the race car that wins the race; it also the driver. An individual must get one’s financial mindset correct before they can succeed and win the race. You are the root of your success. It requires:

  • Right vehicle at the right time
  • Right (general and specific) knowledge, skills and experience
  • Right you…the mindset, character and habit

Never give up…correct and continue.

Effectively, the first step to financial planning and the most important aspect of your financial life, beyond your level of income, budget and investment strategy, begins with your financial mindset and behavior. Without the right mindset around your financial well-being, no amount of planning or execution can improve your current financial situation. Whether you’re having financial difficulty, just setting goals or only mapping out a plan, getting yourself mindset right is your first crucial step.

Knowing your impulsive vices and creating a plan to reduce them in a healthy way while still rewarding yourself occasionally is a crucial part of a positive financial mindset. While you can’t control certain things like when the market takes a downward turn, you can control your mindset, behavior and the strategies you trust to make the best decisions for your future. It’s especially important to stay the course and maintain your focus on the positive outcomes of your goals in the beginning of your financial journey.

Remember that financial freedom is achieved through your own mindset and your commitment to accountability with your progress and goals.

“The first step is to know exactly what your problem, goal or desire is. If you’re not clear about this, then write it down, and then rewrite it until the words express precisely what you are after.” W. Clement Stone

1. Write down your goals—In order to find success, you first have to define what that looks like for you. Many great achievements begin as far-off goals, that seem impossible until it’s done. Though you may not absolutely need a goal to succeed, research still shows that those who set goals are 10 times more successful than those without goals. By setting SMART financial goals (specific, measurable, achievable, relevant, and time-bound), you can put your money to work towards your future. Think about what you ultimately want to do with your money — do you want to pay off loans? What about buying a rental property? Or are you aiming to retire before 50? So that’s the first thing you should ask yourself. What are your short-term needs? What do you want to accomplish in the next 5 to 10 years? What are you saving for long term? It’s easy to talk about goals in general, but get really specific and write them down. Which goals are most important to you? Identifying and prioritizing your values and goals will act as a motivator as you dig into your financial details. Setting concrete goals may keep you motivated and accountable, so you spend less money and stick to your budget. Reminding yourself of your monetary goals may help you make smarter short-term decisions about spending and help to invest in your long-term goals. When you understand how your goal relates to what you truly value, you can use these values to strengthen your motivation. Standford Psychologist Kelly McGonigal recommends these questions to get connected with your ideal self:

  • What do you want to experience more of in your life, and what could you do to invite that/create that?
  • How do you want to be in the most important relationships or roles in your life? What would that look like, in practice?
  • What do you want to offer the world? Where can you begin?
  • How do you want to grow in the next year?
  • Where would you like to be in ten years?

Writing your goals out means you’ll be anywhere from 1.2 to 1.4 times more likely to fulfill them. Experts theorize this is because writing your goals down helps you to choose more specific goals, imagine and anticipate hurdles, and helps cement them in your mind.

2. Create a net worth statement—To create a successful plan, you first need to understand where you’re starting so you can candidly address any weak points and create specific goals. First, make a list of all your assets—things like bank and investment accounts, real estate and valuable personal property. Now make a list of all your debts: mortgage, credit cards, student loans—everything. Subtract your liabilities from your assets and you have your net worth. Your ratio of assets to liabilities may change over time — especially if you pay off debt and put money into savings accounts. Generally, a positive net worth (your assets being greater than your liabilities) is a monetary health signal. If you’re in the plus, great. If you’re in the minus, that’s not at all uncommon for those just starting out, but it does point out that you have some work to do. But whatever it is, you can use this number as a benchmark against which you can measure your progress.

3. Review your cash flow—Cash flow simply means money in (your income) and money out (your expenses). How much money do you earn each month? Be sure to include all sources of income. Now look at what you spend each month, including any expenses that may only come up once or twice a year. Do you consistently overspend? How much are you saving? Do you often have extra cash you could direct toward your goals?

4. Zero in on your budget—Your cash-flow analysis will let you know what you’re spending. Zeroing in on your budget will let you know how you’re spending. Write down your essential expenses such as mortgage, insurance, food, transportation, utilities and loan payments. Don’t forget irregular and periodic big-ticket items such as vehicle repair or replacement costs, out of pocket health care costs and real estate taxes. Then write down nonessentials—restaurants, entertainment, even clothes. Does your income easily cover all of this? Are savings a part of your monthly budget? Examining your expenses and spending helps you plan and budget when you’re building an emergency fund. It will also help you determine if what you’re spending money on aligns with your values and what is most important to you.  An excellent method of budgeting is the 50/30/20 rule. To use this rule, you divide your after-tax income into three categories:

  • Essentials (50 percent)
  • Wants (30 percent)
  • Savings (20 percent)

The 50/30/20 rule is a great and simple way to achieve your financial goals. With this rule, you can incorporate your goals into your budget to stay on track for monetary success.

5. Create an Emergency Fund–Did you know that four in 10 adults wouldn’t be able to cover an unexpected $400 expense, according to U.S. Federal Reserve? With so many people living paycheck to paycheck without any savings, unexpected expenses might seriously throw off someone’s life if they aren’t prepared for the emergency. It’s important to save money during the good times to account for the bad ones. This rings especially true these days, where so many people are facing unexpected monetary challenges. Keep 12 months of essential expenses as Emergency Fund or a rainy day fund.  If you or your family members have a medical history, you may add 5%-10% extra for medical emergencies (taking cognizance of the health insurance cover) to the amount calculated using the above formula. An Emergency Fund is a must for any household. Park the amount set aside for contingencies in a separate saving bank account, term deposit, and/or a Liquid Fund.

6. Focus on debt management—Debt can derail you, but not all debt is bad. Some debt, like a mortgage, can work in your favor provided that you’re not overextended. It’s high-interest consumer debt like credit cards that you want to avoid. Don’t go overboard when taking out a home loan. It can be frustrating to allocate your hard-earned money towards savings and paying off debt, but prioritizing these payments can set you up for success in the long run. But, as a rule of thumb, the value of the house should not exceed 2 or 3 times your family’s annual income when buying on a home loan and the price of your car should not exceed 50% of annual income. Try to follow the 28/36 guideline suggesting no more than 28 percent of pre-tax income goes toward home debt, no more than 36 percent toward all debt. This is called the debt-to-income ratio. If you stick to this ratio, it will be easier to service your loans/debt. Borrow only as much as you can comfortably repay. If you have multiple loans, it is advisable to consolidate all loans into a single loan, that has the lowest interest rate and repay it regularly.

“Before you pay the government, before you pay taxes, before you pay your bills, before you pay anyone, the first person that gets paid is you.” David Bach

7. Get your retirement savings on track—Whatever your age, retirement planning is an essential financial goal and retirement saving needs to be part of your financial plan. Although retirement may feel a world away, planning for it now is the difference between a prosperous retirement income and just scraping by. The earlier you start, the less you’ll likely have to save each year. You might be surprised by just how much you’ll need—especially when you factor in healthcare costs. To build a retirement nest egg, aim to create at least 20 times your Gross Total Income at the time of your retirement. This is necessary to keep up with inflation. But if you begin saving early, you may be surprised to find that even a little bit over time can make a big difference thanks to the power of compounding interest. Do not ignore ‘Rule of 72’ – As per this rule, the number 72 is divided by the annual rate of return on investment to determine the time it may take to double the money invested. There are several types of retirement savings, the most common being an IRA, a Roth IRA, and a 401(k):

  • IRA: An IRA is an individual retirement account that you personally open and fund with no tie to an employer. The money you put into this type of retirement account is tax-deductible. It’s important to note that this is tax-deferred, meaning you will be taxed at the time of withdrawal.
  • Roth IRA: A Roth IRA is also an individual retirement account opened and funded by you. However, with a Roth IRA, you are taxed on the money you put in now — meaning that you won’t be taxed at the time of withdrawal.
  • 401(k): A 401(k) is a retirement account offered by a company to its employees. Depending on your employer, with a 401(k), you can choose to make pre-tax or post-tax (Roth 401(k)) contributions. Calculate how much you will need and contribute to a 401(k) or other employer-sponsored plan (at least enough to capture an employer match) or an IRA.

Ideally, you should save 15% to 30% from your net take-home pay each month, before you pay for your expenses. This money should be invested in assets such as stocks, bonds and real estate to fulfil your envisioned financial goals. If you cannot save 15% to 30%, save what you can and gradually try and increase your savings rate as your earnings increase. Whatever you do, don’t put it off.

After retiring, follow the ‘80% of the income rule’. As per this rule, from your investments and/or any other income-generating activity, you need to generate at least 80% of the income you had while working. This will ensure that you can take care of your post-retirement expenses and maintain a comfortable standard of living. So make sure to invest in productive assets.

8. Check in with your portfolio—If you’re an investor, when was the last time you took a close look at your portfolio? If you’re not an investor, To start investing, you should first figure out the initial amount you want to deposit. No matter if you invest $50 or $5,000, putting your money into investments now is a great way to plan for financial success later on. Market ups and downs can have a real effect on the relative percentage of stocks and bonds you own—even when you do nothing. And even an up market can throw your portfolio out of alignment with your feelings about risk. Don’t be complacent. Review and rebalance on at least an annual basis. As a rule of thumb, your equity allocation should be 100 minus your current age – Many factors determine asset allocation, such as age, income, risk profile, nature and time horizon for your goals, etc. But you could broadly follow the formula: 100 minus your current age as the ratio to invest in equity, with the rest going to debt. And, never invest in assets you do not understand well.

  • Good health is your greatest need. Without good health, you can’t enjoy anything else in life.

9. Make sure you have the right insurance—As your wealth grows over time, you should start thinking about ways to protect it in case of an emergency. Although insurance may not be as exciting as investing, it’s just as important. Insuring your assets is more of a defensive financial move than an offensive one. Having adequate insurance is an important part of protecting your finances. We all need health insurance, and most of us also need car and homeowner’s or renter’s insurance. While you’re working, disability insurance helps protect your future earnings and ability to save. You might also want a supplemental umbrella policy based on your occupation and net worth. Finally, you should consider life insurance, especially if you have dependents. Have 10 to 15 times of annual income as life insurance – If you are the bread earner of your family, you should have a tem life insurance coverage of around 10 to 15 times your annual income and outstanding liabilities. No compromise should be made in this regard. Review your policies to make sure you have the right type and amount of coverage. Here are some of the most important ones to get when planning for your financial future.

  • Life insurance: Life insurance goes hand in hand with estate planning to provide your beneficiaries with the necessary funds after your passing.
  • Homeowners insurance: As a homeowner, it’s crucial to protect your home against disasters or crime. Many people’s homes are the most valuable asset they own, so it makes sense to pay a premium to ensure it is protected.
  • Health insurance: Health insurance is protection for your most important asset: Your health and life. Health insurance covers your medical expenses for you to get the care you need.
  • Auto insurance: Auto insurance protects you from costs incurred due to theft or damage to your car.
  • Disability insurance: Disability insurance is a reimbursement of lost income due to an injury or illness that prevented you from working.

10. Know your income tax situation—Taxes can be a drag, but understanding how they work can make all the difference for your long-term financial goals. While taxes are a given, you might be able to reduce the burden by being efficient with your tax planning. Tax legislation tend to change a number of deductions, credits and tax rates. Don’t be caught by surprise when you file your last year’s taxes. To make sure you’re prepared for the tax season, review your withholding, estimated taxes and any tax credits you may have qualified for in the past. The IRS has provided tips and information at https://www.irs.gov/tax-reform. Taking advantage of tax sheltered accounts like IRAs and 401(k)s can help you save money on taxes. You may also want to check in with your tax accountant for specific tax advice.

11. Create or update your estate plan—Thinking about estate planning is important to outline what happens to your assets when you’re gone. To create an estate plan, you should list your assets, write your will, and determine who will have access to the information. At the minimum, have a will—especially to name a guardian for minor children. Also check that beneficiaries on your retirement accounts and insurance policies are up-to-date. Complete an advance healthcare directive and assign powers of attorney for both finances and healthcare. Medical directive forms are sometimes available online or from your doctor or hospital. Working with an estate planning attorney is recommended to help you plan for complex situations and if you need more help.

12. Review Your Plans Regularly–Figuring out how to create a financial plan isn’t a one-time thing. Your goals (and your financial standing) aren’t stagnant, so your plan shouldn’t be either. It’s essential to reevaluate your plan periodically and adjust your goals to continue setting yourself up for success. As you progress in your career, you may want to take a more aggressive approach to your retirement plan or insurance. For example, a young 20-something in their first few years of work likely has less money to put into their retirement and savings accounts than a person in their mid-30s who has an established career. Staying updated with your financial plan also ensures that you hold yourself accountable to your goals. Over time, it may become easy to skip one payment here or there, but having concrete metrics might give you the push you need for achieving a future of financial literacy. After you figure out how to create a monetary plan, it’s good practice to review it around once a year.

Additionally, take into account factors such as the following:

  • The number of years left before you retire
  • Your life expectancy (an estimate, based on your family’s medical history)
  • Your current basic monthly expenditure
  • Your existing assets and liabilities
  • Contingency reserve, if any
  • Your risk appetite
  • Whether you have adequate health insurance
  • Whether you have provided for other life goals
  • Inflation growth rate

A financial plan isn’t a static document to sit on — it’s a tool to manage your money, track your progress, and one you should adjust as your life evolves. It’s helpful to reevaluate your financial plan after major life milestones, like getting m arried, starting a new job or retiring, having a child or losing a loved one.

Financial planning is a great strategy for everyone — whether you’re a budding millionaire or still in college, creating a plan now can help you get ahead in the long run, especially if you want to make a roadmap to a successful future.

For additional financial planning resources to create your own financial plan, go to the MoneySense complete financial plan kit.

References:

  1. https://www.pewtrusts.org/en/research-and-analysis/articles/2017/04/06/can-economically-vulnerable-americans-benefit-from-financial-capability-services
  2. https://www.forbes.com/sites/forbesfinancecouncil/2020/05/26/your-mindset-is-everything-when-it-comes-to-your-finances/?sh=22f5cb394818
  3. https://www.schwab.com/resource-center/insights/content/10-steps-to-diy-financial-plan
  4. https://www.principal.com/individuals/build-your-knowledge/build-your-own-financial-plan-step-step-Guide
  5. https://mint.intuit.com/blog/planning/how-to-make-a-financial-plan/
  6. https://www.federalreserve.gov/publications/files/2017-report-economic-well-being-us-households-201805.pdf
  7. https://news.stanford.edu/news/2015/january/resolutions-succeed-mcgonigal-010615.html
  8. https://www.investec.com/content/dam/united-kingdom/downloads-and-documents/wealth-investment/for-myself/brochures/financial-planning-explained-investec-wealth-investment.pdf
  9. https://www.sec.gov/investor/pubs/tenthingstoconsider.html
  10. https://www.nerdwallet.com/article/investing/what-is-a-financial-plan
  11. https://www.axisbank.com/progress-with-us/money-matters/save-invest/10-rules-of-thumb-for-financial-planning-and-wellbeing
  12. https://twocents.lifehacker.com/10-good-financial-rules-of-thumb-1668183707

 

Rising Bond Yield Leads to Market Sell-off | CNBC

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The culprit behind the recent stock market sell-off was the rapid rise in 10-Year U.S. Treasury bond yields. The 10-year Treasury yield remained above 1.4%, after surging to 1.6% in the previous day session to its highest level since February 2021 and more than 0.5% higher since the end of January, according to CNBC.

The spike in the 10-year yield , which is used as a benchmark for mortgage rates and auto loans, is reacting to positive economics as vaccines are rolled out and GDP forecasts improve, which should benefit corporate profits. But the move could also signal faster-than-expected inflation ahead. The sheer pace of the rise has also had the effect of dampening investors’ appetite for richly valued areas of the market like technology and other growth stocks. Higher rates reduce the value of future cash flows so they can have the effect of compressing equity valuations.

All three stock benchmarks — Dow Jones Industrial Average , Nasdaq and S&P500 — were tracking for weekly losses ahead of the final trading day of February. The Nasdaq was down nearly 7% from its February 12, 2021, record closing high. The Dow and S&P 500 both remain solidly in the green for the month. However, the S&P 500 was off almost 2.7% from its last record closing high, also on February 12, 2021, and the Dow had its worst day in nearly a month on Thursday.

Additionally, inflation concerns are being stoked on the thought that the $1.9 trillion COVID-19 stimulus bill — which passed the House of Representatives — on top of accelerating growth could overheat the economy.

Economists and investment managers say the bond market is reacting to positive economics as vaccines are rolled out and GDP forecasts improve, which should benefit corporate profits. But the move could also signal faster-than-expected inflation ahead.

References:

  1. https://www.cnbc.com/2021/02/26/5-things-to-know-before-the-stock-market-opens-feb-26-2021.html

Financial Planning and Market Volatility

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“The first rule of investment is ‘buy low and sell high’, but many people fear to buy low because of the fear of the stock dropping even lower. Then you may ask: ‘When is the time to buy low?’ The answer is: When there is maximum pessimism.”  Sir John Templeton

Market volatility is a fundamental part of trading and investing. When market volatility strikes, it’s common for investors to succumb to temptation and follow the herd to panic sell stocks.

Financial Planning is About Long-Term Goals

“All financial success comes from acting on a plan. A lot of financial failures come from reacting to the market.” Nick Murray

Setting financial goals—and sticking with your plan—is key to potential long-term success. Rather than letting market volatility change your long-term financial plans, it is important to stay focused on your long term goals and disciplined in your investment philosophy.

“Your financial goals aren’t set in stone,” according to Mark Gleason, senior manager of investment products and guidance at TD Ameritrade. “Circumstances change, and what you want might change. When that happens, it does make sense to change your approach.”

“Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and mutual funds altogether.” Peter Lynch

Just remember, the time to make adjustments to your long term financial plan are due to changes in life circumstances and should not be in response to market volatility. Here are four reasons to adjust your financial plan:

  1. Change in risk tolerance. If something has happened to change your risk tolerance, making tweaks to your financial plan can make sense. When a recent shakeup forces you to confront where you stand, it might be time to adjust your approach.
  2. New life events. Perhaps there’s been a death in the family. Or you’ve added a new baby to the mix. Maybe you’re getting married or going through a divorce. All of these life events can indicate a change in your financial planning approach.
  3. Shifting to a new life phase. Sometimes your approach needs to change as you actually start approaching your long-term financial goals. When you move from preretirement to actual retirement, your strategy is likely to change. Likewise, if you’ve been growing your child’s 529 and you’re worried about potential market volatility, you might make a few tweaks to the portfolio.
  4. Setting new financial goals. Most people set different financial goals as they move through life. Maybe you decide that buying a home isn’t the goal now; you’d rather get an RV and travel. Perhaps your target retirement age has changed. Whatever the new goal, you might need different financial planning in order to meet it.

Stay disciplined when investing.

Market volatility can cause discomfort, but it is important to realize that market volatility is short term and should not impact your long term goals and financial planning. You’ve set long-term financial goals designed to help you reach certain life milestones—and you don’t want to undo all your progress just to feel better during a market downturn.

“Why is staying the course so important?  As an extreme example, consider the investor who lost faith in the markets and cashed out on March 23, the low point in the U.S. stock market. Stocks subsequently rebounded more than 39% over the next three months; the unfortunate individual who moved to a money market fund earned a meager 0.14%. Vanguard’s analysis found that about 85% of investors who fled to cash would have been better off if they had just held their own portfolio.” (Source:  Vanguard, https://investornews.vanguard/a-snapshot-of-investor-behavior-during-a-downturn/)

Reference:

  1. https://tickertape.tdameritrade.com/investing/financial-planning-setting-financial-goals-amid-market-volatility-18160
  2. https://www.livewiremarkets.com/wires/ten-quotes-on-volatility-from-the-masters-of-the-market
  3. https://investornews.vanguard/a-snapshot-of-investor-behavior-during-a-downturn/

The stock market is not the economy

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The stock market is not the economy, rather it is one variable that indicates how the economy is doing and may perform down the road.

“The stock market is a market where stocks, a type of investment that represents ownership in a company are traded,” said Jessica Schieder, a federal tax policy fellow at the Institute on Taxation and Economic Policy. The stock market is where investors attempt to predict what’s going to happen in the economy or with a company’s stock price.

In contrast, the economy is a sum of goods and services, all of the things produced measured by gross domestic product (GDP).

“The stock market can be moody,” explains Laura Gonzalez, associate professor of finance at California State University, Long Beach. “Sometimes the stock market is positive about the future and sometimes it’s negative about the future.”

So remember, the stock market is not the economy. And the economy is not the stock market. But they are related.

References:

  1. https://www.marketplace.org/2019/09/30/the-stock-market-is-not-the-economy/

Asset Allocation

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Asset allocation is one of the most important factors in your success as a long-term investor according to many financial experts. It’s a hundred times more important than any stock pick and more important than knowing the next hot country to invest in… what option to buy… what the housing market is doing… or whether the economy is booming or busting.

Asset allocation is how you balance your wealth among stocks, bonds, cash, real estate, commodities, and precious metals in your portfolio. This mix is the most important factor in your retirement investing success.

Ignorance of this topic has ruined more investment and retirement portfolios than any other financial factor. Many investors have no clue on what a sensible asset allocation should be. So they end up taking huge risks by sticking big chunks of their portfolios into just one or two investment assets.

For example, people who had most of her wealth in real estate investments in 2008 experienced significant losses when the market busted in 2009. Or consider employees of big companies that put a huge portion of their net worth or retirement money into their company stock. Employees of big companies that went bankrupt, like Enron, WorldCom, Bear Stearns, and Lehman Brothers were totally wiped out. They believed in the companies they worked for, so they kept more than half of their retirement portfolios into company stock.

And it’s all because they didn’t know about proper asset allocation. Because of this ignorance, they lost everything. These examples demonstrate why asset allocation is so important because keeping your wealth stored in a good, diversified mix of assets is the key to avoiding catastrophic losses.

If you keep too much wealth – like 90% to 100% of it – in a handful of stocks and the stock market goes south, you’ll suffer badly. The same goes for any asset… gold, oil, bonds, real estate, or blue-chip stocks. Concentrating your retirement nest egg in just a few different asset classes is way too risky. Betting on just one horse or putting your eggs in a single asset basket is a fool’s game.

Spread your risk around.

A sensible asset mix should include five broad categories… cash, stocks, bonds, real estate, and precious metals. And, a favorite asset of all long-term investors should be cash. “Cash” simply means all the money you have in savings, checking accounts, certificates of deposit (CDs), and U.S. Treasury bills. Anything with less than one year to maturity should be considered cash.

It’s best to keep plenty of cash on hand so you can be ready to buy bargains in case of a market collapse. Investors flush with cash are often able to get assets on the cheap after a collapse – they can swoop in and pick things up with cash quickly, and often at great prices.

Generally, it’s recommended to hold between 10% and 15% of your assets in cash, depending on your circumstances. In fact, one of the major tenets of good financial planning is to always have at least 6 to 12 months of essential living expenses in cash in case of disaster. If you haven’t started saving yet, this is the No. 1 thing to start today.

Next, you have conventional equity stocks. These are investments in individual businesses, or investments in broad baskets of stocks, like mutual funds and exchange-traded funds (ETFs). Stocks are a proven long-term builder of wealth, so almost everyone should own some. But keep in mind, stocks are typically more volatile than most other assets.

Just like you should stay diversified overall with your assets, you should stay diversified in your stock portfolio. Once, a well-known TV money show host ask callers: “Are you diversified?” According to him, owning five stocks in different sectors makes you diversified. This is simply not true. It is a dangerous notion.

The famous economist Harry Markowitz modeled math, physics, and stock-picking to win a Nobel Prize for the work on diversification. The science showed you need around 12-18 stocks to be fully diversified.

Holding and following that many stocks might seem daunting – it’s really not. The problem is easily solved with a mutual fund that holds dozens of stocks, which of course makes you officially diversified.

Next you have fixed income securities, with are generally called “notes” or “bonds.” These are basically any instrument that pays out a regular stream of income over a fixed period of time. At the end, you also get your initial investment – which is called your “principal” – back.

Depending on your age and tolerance for risk, bonds sit somewhere between boring and a godsend. The promise of interest payments and an almost certain return of capital at a certain fixed rate for a long period of time always lets me sleep well at night.

Adding safe fixed-income bonds to your portfolio is a simple way to stabilize your investment returns over time. For people with enough capital, locking up extra money (more than 12 months of your expenses) in bonds is a simple way to generate more income than a savings account.

Another asset class is real estate. Everyone knows what this is, so we don’t need to spend much time covering this. If you can keep a portion of wealth in a paid-for home, and possibly some income-producing real estate like a rental property or a farm, it’s a great diversifier.

Precious metals, like gold and silver, an important piece of a sensible asset allocation

Precious metals, like gold and silver, are like insurance. Precious metals like gold and silver typically soar during times of economic turmoil, so it’s wise to own some “just in case.” Avoid the mindset of the standard owner of gold and silver, who almost always believes the world is headed for hell in a hand basket. You should remain an optimist, but also a realist and own insurance. Stay “hedged.”

For many years, the goal with hedging strategies was to protect wealth and profits from unforeseen events. Wealthy people almost always own plenty of hedges and insurance. They consider what could happen in worst-case scenarios and take steps to protect themselves. Poor people tend to live with “blinders” on.

So just like wearing a seat belt while driving or riding in a vehicle, it’s important to own silver and gold – just in case. For most people, most of the time, keeping around 3% to 5% of your wealth in gold and silver provides that insurance.

Asset allocation guidelines

There’s no “one size fits all” asset allocation. Everyone’s financial situation is different. Asset allocation advice that will work for one person, can be worthless for another.

But most of us have the same basic goals: Wealth preservation… creating safe consistent income… and safely growing our nest egg. We can all use some guidelines to help make the right individual choices. Keep in mind, what I’m about to say are just guidelines…

If you’re having a hard time finding great bargains in stocks and bonds, I think an allocation of 15%… even 20% in cash is a good idea.

This sounds crazy to some people, but if you can’t find great investment bargains, there’s nothing wrong with sitting in cash, earning a little interest, and being patient. If great bargains present themselves, like they did in early 2009, you can lower your cash balance and plow it into stocks and bonds.

As for stocks, if you’re younger and more comfortable with the volatility involved in stocks, you can keep a stock exposure to somewhere around 65%-80% of your portfolio. A young person who can place a sizable chunk of money into a group of high-quality, dividend-paying stocks and hold them for decades will grow very wealthy.

If you’re older and can’t stand risk or volatility, consider keeping a huge chunk of your wealth in cash and bonds… like a 25%-35% weighting. Near the end of your career as an investor, you’re more concerned with preserving wealth and keeping up with inflation than growing it, so you want to be very conservative.

As a guideline, the big thing to keep in mind with asset allocation is that you’ve got to find a mix that is right for you… that suits your risk tolerance… your station in life. Whatever mix you choose, just make sure you’re not overexposed to an unforeseen crash in one particular asset class. This will ensure a long and profitable investment career.

In summary, asset allocation is how you balance your wealth or net worth assets among stocks, bonds, cash, real estate, commodities, and precious metals in your portfolio. It is the single most important factor in your success as an investor.

References:

  1. https://stansberryinvestor.com/media-article/328231?fbclid=IwAR2z_5CGah4ZGsSJPoMsSX8Tb9jExRTJIWmedbMI7Il18Wjii8RtjzFTDLg
  2. https://www.investopedia.com/terms/h/harrymarkowitz.asp

It’s a Stock Market Bubble | Barron’s

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Excerpts from Barron’s article entitled:Yes, It’s a Stock Market Bubble. That Doesn’t Mean Trouble for Investors Just Yet.

By Ben Levisohn, September 12, 2020

“Every stock market bubble begins with a story.”

“”The story began easily enough, if not with “once upon a time.” A virus forced the country to shut down and accelerated the gains in a select few technology stocks that are uniquely capable of thriving with everyone stuck at home. A central bank took quick action to prevent financial markets from seizing up, pushing interest rates about as low as they could go. That helped lift the stocks of companies that are growing, including chiefly the aforementioned tech stocks, even if some have no profits. These stocks were among the first to rally once the stock market bottomed in March.”

“Now, get ready for the plot twist: Good investment ideas can stop being good ideas if the story goes on for too long. The tech trade—including tech companies that aren’t officially labeled as such—went too far before correcting suddenly in the past two weeks.”

“The forces that drove stocks such as Apple and Amazon.com to astonishing heights remain firmly in place. They include the companies’ continued growth, the Federal Reserve’s determination to do whatever it takes to keep the economy afloat, retail investors’ newfound interest in trading, and maybe even a bit of fiscal largess.”

Stocks will remain volatile, but the tech bubble will continue to inflate.

“For an investment bubble to occur, there has to be a widespread belief that a new paradigm has taken hold requiring an adjustment in valuations far beyond what previous fundamentals would imply. This belief needs to engage the imagination of investors beyond Wall Street, and there must be plenty of capital available to chase stock prices higher. The Covid-19 crisis has unlocked all three prerequisites.”

“Consider how the world has changed in the past six months. Social distancing is now the rule, and working from home is encouraged, when possible. Movie theaters are half-empty, and attending school now means opening a laptop at home for many students.”

“Companies that bring us a taste of our previous lives—such as Zoom Video Communications (ZM) and Peloton Interactive (PTON)—have seen their share prices soar. Shares of tech titans Apple, Microsoft (MSFT), Amazon, Alphabet (GOOGL), and Facebook (FB) have risen because the businesses are growing far more than most, and investors know that bigger is better in today’s world.”

“Some retail investors, starved for something to bet on in the absence of professional sports, have turned their attention to stocks.”

“At the same time, near-zero interest rates have encouraged investors to pay up for growth, while some retail investors, starved for something to bet on in the absence of professional sports, have turned their attention to stocks, trading through online brokers like it’s 1999.”

“As a result, Apple, Amazon, Microsoft, Alphabet, and Facebook now account for nearly a quarter of the value of the S&P 500 index, a level of concentration rarely seen in the benchmark. And that might understate the influence of Big Tech. Add Amazon and the S&P Information Technology and Communication Services sectors constitute 45% of the benchmark index, according to J.P. Morgan data, compared with 40% during the dot-com bubble.”

“Even as the biggest tech names have seen market caps swell, some formerly small companies have graduated to the big leagues. Zoom, for one, jumped 41% in a single day after reporting sales that more than quadrupled the previous year’s, a consequence of the video service’s widespread adoption beyond a business audience. Zoom stock, having zoomed 465% in 2020, is now worth more than $100 billion. Peloton has a market cap of $25 billion after gaining 209% this year, as its stationary bikes replaced gym memberships.”

“Zoom trades for 50 times 2020 sales, and Peloton, 9.3 times. Both are priced as if future growth is unlimited—a risky bet, especially if the postvirus world looks not all that different from the previrus world.”

The Fed has pumped trillions of dollars into the economy

“Behind the scenes, meanwhile, the Fed is operating the bubble-making machinery. It has pumped trillions of dollars into the economy, expanding its own balance sheet to more than $7 trillion from $4.1 trillion at the start of 2020. This time around, its asset purchases have included not only Treasuries and mortgage-backed securities but also investment-grade and high-yield bonds. All of this demand has served to lower interest rates to near zero.”

“The Fed typically has burst past bubbles, including the dot-com bubble of the late 1990s and the housing bubble of the mid-2000s, by raising interest rates. Don’t count on that now, or at least not yet. Fed Chairman Jerome Powell has effectively promised to keep rates low for years, which means there should be plenty of cash sloshing around to keep the bubble growing.”

“Perhaps the biggest reason to keep betting on tech—and the stock market—is that things aren’t nearly as frothy now as they were during, say, the dot-com bubble. Even in August, the market never reached the sustained frenzy that characterized the late 1990s, when the major indexes went parabolic and stayed that way for months, says Katie Stockton, managing partner of Fairlead Strategies. Stockton thinks the market’s recent pullback will create another buying opportunity, “A bubble would be characterized by prolonged upside momentum,” she says. “The market doesn’t have that.””

To read more: https://www.barrons.com/articles/the-market-is-a-bubble-but-that-doesnt-mean-troubleyet-51599862332?st=zdbk5yoalgbsduv

Source: https://www.barrons.com/articles/the-market-is-a-bubble-but-that-doesnt-mean-troubleyet-51599862332?st=zdbk5yoalgbsduv