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Market volatility, this year notwithstanding, tends to unnerve even the calmest of investors. When the market is dropping, investors like holding assets that maintain their value. When the market is going up, they prefer assets that are going up, not just holding steady. So how do we get the best of both worlds? How do we know what to hold and how much to hold at any particular time? That’s a crucial question, but the answer does not need to be complicated.

The amount of portfolio assets an investor holds in cash/bonds (aka fixed income) should be determined by cash flow needs. Think of it as your lifeboat. If the market is tanking, the last thing you want to do to create cash is to liquidate stock. Ideally, those growth assets would be given time to recover. Buy low, sell high, not the other way around. Investors must be able to remain invested through some difficult market downturns to achieve better long-term results. Preservation assets like bonds help buffer these near term bumpy roads and reduce investor angst.

So what exactly are “cash flow needs”? Think of someone nearing or in retirement. Income from employment has or will be ceasing. Thus the portfolio becomes a source for maintaining a certain standard of living. In preparation for that time, individuals should take steps to have enough cash and bonds in their portfolio to cover approximately eight years’ worth of their distribution needs. Historically, this level of cushion has been enough to weather virtually all market corrections. If stock and/or real estate markets decline, this lifeboat of preservation assets provides ample liquidity to sustain us while we wait for an expected recovery.

What if you do not have any immediate cash flow needs from the portfolio? Depending on your time horizon, it may make sense to have an investment line-up exclusively allocated to the equity markets. If growth is the goal for the foreseeable future and there is an understanding that markets will go up and down, then an all-equity portfolio can be reasonable. Advantages of having some fixed income exposure include having “dry powder” for rebalancing, as well as a degree of diversification for risk management.

For example, when stock markets declined in February, investors with fixed income in their portfolios were afforded the opportunity to deploy additional capital into those equity markets, in effect, “buying low”. As the market turns upward in later time periods, the investor owns more shares that have been purchased at lower prices. Simple stuff.

Remember, buy low, sell high. This tactic is not based upon a prediction nor timing effort. That’s fools’ gold. Rather, it is predicated on what percent of your portfolio ought to be in the stock market versus out of the stock market. What does your plan suggest the portfolio needs to do to meet your individual goals? From there, you have no need to take more risk than necessary. Build a diversified, low-cost portfolio in accordance with your plans. Keep the lifeboat intact and stay diversified. Wait, did I already say that?

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