What concepts can I use to guide the allocation of assets in my portfolio?
I am 65 years old. I have $1,500,000 from divorce proceedings. What concepts can I use to guide the allocation of my assets in my portfolio?
I generally address this question by asking a client to provide their annual budget. What will it cost you, per year, to live? I don't mean just the basic food, shelter, utilities, taxes, etc.; I also ask for what you will spend on travel, entertainment, meals, hobbies, gifts and the other pleasures of life. Then, add something for emergencies (a new car, a new roof, an accident or illness) knowing that those will not occur every year, but can be large when they do occur.
Then, take that number and subtract all income from all sources -- your Social Security (which you should possibly wait to take until you turn 67); your spouse's, if applicable; any other pension income or retirement assets. The result is the amount you will need to take from your investments every year. At this point your primary goal is to make sure that whatever happens in the capital markets, you will have enough to sustain you for the rest of your life. There are general rules-of-thumb for this -- you probably can stay solvent over the long term by taking $60,000 or less per year, I would think -- but no hard-and-fast rule that applies to everyone. Those of us responding to you don't know, for example, whether you might expect to receive an inheritance some time in the future; and you have not stated what other savings you have. So that number could grow.
If you have any questions, feel free to get in touch.
There is no cookie cutter method for asset allocation; each individual has their own risk tolerance, income needs, etc. It is best to visit with a Financial Advisor and have a recommended allocation for you specifically after going over all of your personal financial information.
Keep in mind that portfolio construction can make a significant difference in performance, particularly during the retirement drawdown phase. By having your assets allocated to stocks, bonds, cash as well as alternative investments may increases performance over time. With a smaller allocation to alternative investments that are non-correlated to the stock or bond market especially in volatile times.
Five key concepts for portfolio allocation include:
- Diversify your risk (example: use ETFs)
- Consider your time horizon (example: gradually reduce volatility exposure)
- Prioritize your goals (example: ensure funds are liquid when you need them)
- Leverage your tax obligations (example: Roth IRA conversion vs. taxable account)
- Control your principal (example: refuse to fall prey to fear and forfeit your balance with an annuity)
First, some homework is in order. Refer to or if you do not have one prepare a simple net worth statement which will assist in guiding you to what other assets you might have to provide for your support. Then determine how much income you need to support yourself monthly and annually. Next, explore your personal risk tolerance, there are online calculators to assist in this process.
Once you have these questions answered begin putting together a diversified portfolio of stocks, bonds, and cash. Your portfolio should include U.S. as well as foreign stocks and bonds. Some of the investments will produce dividends to assist with your cash flow/income others will be growth oriented to provide for your future. If you own your home this might meet your real estate investment category, if not you might consider adding a REIT (real estate investment trust) to provide a hedge against inflation. Consider investing in sections over a period of months to smooth price movements in this current volatile market.
If all of this seems to be more than you are ready to manage and monitor, you might consider a target date fund for some of your investment assets. Vanguard, Schwab and TD Ameritrade all have target date options. These investment vehicles put the allocation of stocks and bonds together for you.
Last, you have the assets to consider hiring a professional to assist you with the planning and investment management. The fees you pay should come back to you in a steady return, education, and peace of mind.
Look for a fee-only fiduciary, preferably a CFP (Certified Financial Planner). NAPFA has lists of qualified professionals in your area.
Best of luck!
Hi there, thank you for the opportunity to address your question. There are a variety of concepts you can use to guide the allocation of your portfolio and professional portfolio managers will probably use a greater number of them and in combinations that attempt to improve the probability of you attaining your goals. Below are a few I believe you can start with and expand from there as you become more familiar with the process of managing your portfolio.
- Goals - in order for you to figure out how to allocate your portfolio, you must first figure out your financial goals, including income needs/wants, other assets (including other investments), liabilities, income from other sources, and expenses, both fixed and variable. Generally speaking, this type of analysis is called a financial plan and it will serve as a guideline for how you should invest your portfolio.
- Asset allocation strategy - this is the concept of having an overall plan for your portfolio based on the financial goals identified in the financial plan. An asset allocation strategy will dictate your target return, risk tolerance, liquidity needs, tax situation, and others. It does this by defining how much of your portfolio will be allocated to each asset class, such as equity, fixed income, or alternatives (real estate, for example) such that the combination of these assets increases the probability of generating your desired return within the risk that you are comfortable with. The asset allocation strategy is comparable to a recipe for a good meal. The right combination of ingredients creates just the right level of tastes, fragrances, and textures for a fantastic meal. Where as a lack of cohesion or planning might result in a meal being too salty, or too heavy, etc. Too often we see portfolios of stocks that on their own make sound investments, but whose combination results in unwanted risks or exposures.
- Diversification - its important for a portfolio to have enough diversification so that a decline in one asset class or position is less onerous on the portfolio than if the portfolio was concentrated in one position the declines. For example, if a position makes up just 5% of a portfolio and it declines by 50%, the portfolio will only decline by 2.5%, provided all other positions remain the same. On the other hand, if that position makes up 50% of the portfolio (only two positions in the portfolio), then a 50% decline in that position will result in a 25% decline in the overall portfolio. How do you know if you are well diversified? If on a monthly basis, all of your positions move in the same direction (either all go up or all go down) and it occurs frequently, you are probably not well diversified. That means that not only do you need to have an adequate number of positions in your portfolio, but you should also have positions that exhibit different characteristics.
- Rebalancing - setting and forgetting is a dangerous approach to investing. Over time, some positions will outperform others, resulting in weights to each position that are quite different than the original allocation. In these cases, and as frequently as monthly, a portfolio should be monitored so that positions that have deviated considerably from their initial allocations can be rebalanced. That means selling those positions that have a higher allocation than the original allocation and reinvesting in the positions that are below their original allocation. For example let's say you have two positions and your original asset allocation strategy is to have 50% in A and 50% in B. After a few quarters, A has outperformed B such that A now makes up 60% of your portfolio and B makes up only 40%. In this case, you would sell 10% of A and invest it in B so your ending balance is back to the original 50/50.
There are quite a few other concepts involved in managing portfolios - too many to list here - but I hope this gives you some insight on where you could start the process.
Good luck and please reach out if you need any clarification.
Arturo Neto, CFA