By DAVID MOON, Moon Capital Management
January 11, 2004
When the stock market has the kind of performance we enjoyed in 2003, it gets
people thinking about their investments again. Sadly, a favorite
investment strategy of some people the last few years involved sand and the
insertion of their heads into it.
But after stocks increased twenty or thirty or fifty percent last year, it
seems safe to once again look at your brokerage statements and think about a
plan. For most people, this will involve increasing their allocation to
stocks. When stocks enjoy positive performance in a calendar year, money
will flow into stock mutual funds in January. Of course, that's a horrible
reason to buy stocks - simply because they've already gone up - but that's not
going to stop a lot of people from doing it anyway.
Instead of habitually jumping from one place to another (usually a year after
the most opportune time,) most folks ought to decide on a specific allocation
between types of investments - and then stick to that allocation unless there is
something that changes in the assumptions used to initially determine the
The process to determine an appropriate asset allocation is part logic and
part emotion. Depending on your personality, it easy to let one of those
influences dominate. The logic part of the equation is easy.
Determine the return you need to earn on your investments to achieve the
financial goals you desire. Then invest in an asset class (or combination
of asset classes) that has the highest likelihood of generating that needed
return between now and the time you'll need the money. It's pretty simple
But this simple algebra can easily suggest an allocation that is outside of
the comfort level (here is the emotional part) of an investor. If you need
to generate an average annual return of ten percent over the next five years to
meet your goals, you aren't likely going to get there owning five-year treasury
bonds. You're going to need to own something more risky, more volatile,
than short-term treasuries.
So you decide to put all of your money in stocks. After all, last year
that would have earned you more than twenty percent. And if you can wait
long enough, riding out the ups and downs, surely you'll achieve your
ten-percent return goal.
But what if this year isn't a repeat of last year? What if it is more
like 2000 or 2001 and you lose thirty percent? How will you feel if your
$250,000 retirement plan is suddenly worth $175,000? In your head you know it
will recover. But your stomach still hurts and you can't sleep at
To pick the proper asset allocation, you have to understand your goals,
resources and investment alternatives. But you also need to understand
yourself. Then you can decide on an appropriate allocation.
Then you need to stick with it.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).