Wealth Notes – February 8, 2013
Prices Matter When Allocating Your Portfolio
By Rob Wrubel, CFP®, AIF®
Investing literature and conversations are filled with great phrases. “Buy low and sell high.” “Don’t put all your eggs in one basket.” “Save for a rainy day.” “No risk, no reward.” “Bulls make money, bears make money, pigs get slaughtered.” Each phrase has an element of truth to remember when building your portfolio or saving and investing to reach your goals.
At Cascade Investment Group, we like to start with the basics. “Save for a rainy day” is an old maxim that works time and time again. We usually recommend you keep cash on hand – either in accounts here that sit in money market funds or in bank savings accounts – to use when there is an emergency or immediate need for funds. The basics of financial planning call for a cash reserve of three to six months of such funds. Rainy days might look like lost employment, calls for business loans, medical emergencies or other unforeseen circumstances. We also like to see cash on hand that can be used for unique opportunities like expanding a business by buying a competitor, snapping up a piece of real estate when markets allow or funding retirement and education accounts more than expected.
We are strong believers that our clients with comprehensive financial plans have higher success rates in accomplishing their goals than people who do not have a comprehensive plan. Recent study by Michael Finke and Terrance Martin shows that individuals that they studied created retirement wealth about four times greater than those without a comprehensive plan.
We think those of you who put a plan in place have a higher savings rate than those that do not. We think those with a plan are more likely to not over-react to market changes. We think those with a plan seem to increase contributions to savings and investing as they earn more through the years.
A cornerstone of the investment side of this plan is summed up in the phrase “Don’t put all your eggs in one basket.” This phrase can be used to talk about the idea of diversification or asset allocation.
Diversification means owning many different types of securities or holdings. You do not want to own just one company. Shareholders who owned only GM, Enron, Qwest or other companies saw all or most of their value wiped out. Those with ownership in multiple companies saw asset values increase over time even as one or two companies performed poorly or lost 100% of value.
Asset allocation involves taking your investment money and dividing it into different asset classes. These asset classes are typically stocks, bonds and cash. Portfolios these days may also include other asset classes like publicly traded real estate (REITs), Master Limited Partnerships (MLPs that usually invest in the oil and gas industries), commodities, precious metals and currencies.
The big three asset classes, cash, bonds and stocks, are the ones most often used in modeling portfolios and as the basis of financial plans. These classes have the most real-world testing and longest track records. Typically, investors think of using stocks for long-term capital gains, bonds to generate income and cash to preserve capital. The last decade saw the standard models turned upside down to a degree as there were periods where bonds performed like stocks with above average returns and cash and stocks barely held ground to inflation.
We use several factors in determining which asset classes to use and in which proportion. Time horizon of need is the biggest, usually. Risk tolerance matters as we often need to hold stocks and bonds through different market cycles. Cash flow, tax planning, account types, debt and income levels and other factors need to be considered too.
Asset classes should be rebalanced regularly. We see new client portfolios that are too weighted towards one asset class – either the portfolio was neglected over time or the hot asset class was bought recently. The rebalancing process should be part of a disciplined investment and financial planning review.
Asset prices matter. Bonds have done extremely well over the past five years. Bond values tend to go up when interest rates go down. The Federal Reserve has done much to keep interest rates low which has lead to big gains in bonds. We do not think this can continue – there is little room for interest rates to go down and they will most certainly increase as the economy does better. It looks like bond prices are high relative to history, inflation and cash flow potential.
We have been reviewing bond holdings in our client portfolios and have been looking for ways to preserve capital as interest rates rise and replace the expected income of the bonds. We have been reallocating bond money to stocks, cash and to some of the publicly traded alternative choices.
The process of asset allocation does not include jumping from one asset class to another or making changes without regard to the financial plan. Bonds, even if overpriced, have a role in a portfolio. Stocks, even when they look undervalued, have risks and volatility that need to be thought through and planned for.
Will Rogers is famous for saying, “The quickest way to double your money is to fold it over and put it back in your pocket.” We think there is a better way – rational investing based on your specific financial needs and strategies well-tested and studied in investment journals and practice.
We work with you to build an allocation that fits your plans and adapt the investments over time to fit those plans and current market conditions. We look forward to our conversations about your life, your money and where we think there is opportunity for growth and income in the coming years.
Rob Wrubel CFP®, AIF®, is a Senior Vice President, Investments with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.
