Foster Group

An agenda topic in many client meetings is portfolio allocation. Generally, when we talk about allocation, we’re referring to the percentage of equities (stocks or stock-owning mutual funds) and the percentage of fixed income (bonds or bond-owning mutual funds) held in your portfolio. We’re asking if the mix you currently hold remains appropriate or if it should be changed for some reason. Perhaps you plan to retire sooner than you had thought or you’re receiving an unexpected inheritance.

Why is allocation important? Because it’s the largest single factor determining the risk of your portfolio. We want you to participate in equity markets for long term-growth and, ideally, have enough fixed income in your portfolio so that any necessary distributions will not require you to sell equities in a down market cycle. Planned selling of equities to rebalance your portfolio or to intentionally realize a gain makes sense when managing a portfolio, but being forced to sell equities when their values are depressed is not a good thing. Having adequate funds available in short-term, high-quality fixed income funds, allows needed distributions to be taken from that portion of your portfolio, giving equity positions time to recover.

Sometimes (i.e., late 2008 into early 2009) equities markets experience negative cycles lasting several months or as long as several years. When this happens, it’s pretty uncomfortable for most investors. Having been through this multiple times in my career (that’s right, I’m old!) I can tell you that a significant percentage of folks who are comfortable with high equity exposure most of the time (i.e. when equity markets are positive) feel much less confident in these down market cycles. No one likes watching their portfolio value decline.

A well-thought-out allocation devoting plenty of funds to short term, high quality fixed income positions that will plug away and hold their value, ready to come to your aid should you need cash, allows you to more easily stomach the lurches of a negative equity market period. How much should you devote to these types of positions? That differs for each investor and depends on a number of factors including your age, how long you plan to work, other financial resources you may have in addition to your portfolio and what we refer to as your "sleep well factor."

As a rule of thumb, here is a broad generalization: If you are within five years of retirement, work toward moving your allocation so that at retirement you have about 8 years of planned distributions held in fixed income. Don’t assume more risk than necessary. In other words, if you have a sizeable portfolio - more than you’ll reasonably need for lifestyle expenses during your lifetime - you may not need to take much risk, so why would you want to do so?

If you’re just beginning your investing career and have a long time until you plan to need distributions, say 15 to 20 years or more, a higher level of equity exposure may be appropriate. You might be comfortable investing 70, 80 or even as much as 90% of your portfolio in equities. This might be appropriate for you, assuming you sleep well with your portfolio invested heavily in equities, even when the stock market is declining for months on end. Cautionary Note: you won’t accurately understand your "sleep well factor" until you’ve been through a down market cycle or two. It’s a factor based on emotion, not intellect or reason and - trust me on this - you are not immune.

If you haven’t had an allocation discussion with your advisor recently, think about adding it to the agenda of your next meeting to make certain the allocation you have is appropriate for your future. If not, together you can decide what needs to change.