Once allocation is made, stick with it

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 allocation.

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 algebra.

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 night.

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).

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