Mixing Things Up

Determining the Right Mix for Your Investment Portfolio

BY MICHAEL P. HAUBRICH, CFP

April 4, 2002

If only financial advisors had a crystal ball to assist us in determining the exact right moment to buy or sell… ah, life would be so much easier and more profitable! Alas, we have to rely on experience, industry knowledge, and timing to make up for what we lack in prognostication. However, diversifying investment funds among various asset classes is an area where your financial advisor can help without special consultation with Houdini.

    The asset allocation between stocks, bonds, and cash, represent about 90% of the variation in returns, meaning that stock selection and/or timing have very little overall impact. The magic formula for investment success comes in the completely earthly form of deciding how you want your investments allocated among the asset classes.

    Selecting your mix begins with a careful analysis of your financial planning goals and objectives. It’s advisable to consult with a professional to help you work through your unique situation to develop a financial plan that is consistent with your overall life plan. Your objectives could include preserving your wealth and/or principal, growing your assets, or minimizing your tax exposure. These objectives, coupled with your risk tolerance and the length of time you have until you’ll need to access your investment, will impact your allocation strategy.

    Conjuring up your particular asset class mix involves understanding the risks and opportunities associated with each. For example, stocks have historically outperformed other asset classes over the long term. The exchange for undertaking the higher risk generally associated with this class is the potential for greater gains over time. However, it would not be advisable for an investor with a low risk tolerance and/or less time to invest to have a large portion of their portfolio in stocks. Investors nearing retirement age often invest less and less in equity investments, opting for investments that are less likely to have a high degree of volatility.

    There are many different types of bonds to consider when determining your asset allocation mix as well. Included is U.S. government securities, municipal bonds, corporate bonds, mortgage and asset-backed securities, federal agency securities and foreign government bonds. Short-maturity options such as Treasury bills and bank certificates of deposit are also included in this asset class. Investors also have numerous options in investing including purchasing individual bonds, bond funds or unit investment trusts.

Investors can benefit from the advantage some bond types offer in terms of receiving more predictable interest income, offering special tax advantages, preserving wealth, or accumulating capital. There are many types of bonds from which to select and, once again, that decision should be based on your financial and life planning objectives and risk tolerance. It’s important for bond investors to realize that if you are forced to sell a bond before its maturity, you will receive whatever the market price is at the time of the sale. That price could be greater or lower than the price you paid for the bond initially.

    The third type of asset class is cash or cash equivalents that can easily be converted to cash. Having a portion of your portfolio in this class helps ensure a ready supply of cash for an unanticipated life event or for expenses associated with retirement.

    An experienced Certified Financial Planner can assist you in taking the illusion out of your investment allocation choices. In identifying the facts that are unique to your situation, an appropriate mix of stocks, bonds, and cash can be calculated and a plan implemented that could help spell success for your financial future.

Michael Haubrich, CFP, is president of Financial Service Group, Inc., a registered investment advisory firm in Racine, website address www.toyourwealth.com.