Rick Ferri wrote: ↑Fri Oct 24, 2008 10:32 am
[If you are reading this for the first time, please note the post dates - admin alex]
That is a question I have been getting quite frequently. Rather than post ad-hoc when this topic comes up, I decided to make my own post that slices together some advice that I have already put on this forum.
What should you do in this current market environment?
First, do not act emotionally. Think things through before making any changes. Second, if you decide to make a radical change, don't do it until next week. Chances are you will change your mind again by then.
Here is how I believe people should handle the current situation based on how I classify investors;
* 1) Early Savers (20s and 30s) - buy equities index funds like crazy with what you can and do not look at your account balance for 10 years.
* 2) Mid-life Accumulators (40s and 50s) - rebalance your portfolio back into equities when it needs to be rebalanced, and you will be very happy you did by the time you retire.
* 3) Near Retirees and retirees (60s and 70s) - live off your cash flows from dividends, interests, Social Security, pensions, annuities, and other. Leave your principal alone.
The only people who should be concerned are those who are currently taking out 7% or more per year from their portfolio to live on. This situation is just as much a budgeting issue as a portfolio management issue. My first response is to spend less. However, if spending cannot be controlled, then there may be a legitimate reason to change an asset allocation because the portfolio was more aggressive than it should have been
from the beginning. Looking further at this topic:
When should you change your asset allocation strategy?
Significant changes to your stock and bond asset allocation strategy is a major decision and can be compared to changing careers. There are several good reasons to change your asset allocation strategy along life’s journey. Below are three reasons I believe a person has a legitimate reason to make an asset allocation change:
1) Your target retirement goal is well within reach.
2) You realize that you will not need all your money during your lifetime.
3) You have realized that your tolerance for risk is not as high as you once thought.
Consider a reduction to risk when you are within reach of your financial goals. That is the time to take your foot off the gas pedal and move into the middle lane. For example, assume you wish to retire in 3 years with $2,000,000 in retirement savings. If you already have $1,800,000 in savings, the rate of return you need to achieve your goal does NOT require a high risk asset allocation strategy. It might be time to permanently lower your equity exposure because you no longer need to take as much risk.
Second, a change to your asset allocation strategy may be appropriate if you realize that you will not outlive your money and will likely have excess assets. In that case, you are investing part of your portfolio for yourself and another part for the needs of those who will inherent your wealth. Your overall asset allocation should reflect the needs of both parties jointly. Assume you have $2,000,000 in retirement savings. You may need $1,000,000 of that amount which might be allocated at 30 percent stocks and 70 percent bonds. The second $1,000,000 will be passed on to your heirs. Since heirs tend to be younger, they can be more aggressive. That portion might be allocated at 70 percent stocks and 30 percent bonds. With both allocations put together, an appropriate asset allocation strategy for this example might be a portfolio that is 50 percent stocks and 50 percent bonds.
The third reason to change an allocation is because you have taken on more risk than you can handle. If you are not sleeping at night because you are worried sick about your portfolio, and you are on the verge of making an emotional decision to ‘sell it all”, then you should consider permanently reducing your equity position to see if that helps. Your portfolio has an appropriate level of risk when you are able to think clearly during all market conditions. Once you find this level of risk, stay at that level, even when the market recovers.
I hope this helps!
Rick Ferri