One of the first books I read about being financially literate was “Rich dad, poor dad”. One of the concepts discussed profoundly in this book is asset allocation. Numerous articles have been dedicated to this topic. The answer on the other hand isn’t straight forward. As a matter of fact, it all depends on your personal profile and the amount of risk you want to put in the game.
There’s already something wrong with the previous sentence because I don’t consider “risk” as the correct word. More like calculated exposedness. Yes… I googled synonyms for the word “risk”.
Perhaps I’ll start of with a brief explanation of what asset allocation actually is. The term refers to the amount of money you invested in the stock market versus the amount of money invested in bonds. Technically, there’s also a third cashflow class but I’ll leave that one out as this refers to money in the bank, practically sleeping. When somebody says his allocation is set to 70/30, it means 70% sits in stocks (equity), 30% in bonds. The more you lean towards bonds investing, the lower your risk will be, hence, the lower your return (yield/profit). Therefore, when you’re in the accumulation phase, people tend to put more money towards equity because the returns are higher.
In periods of high volatility (e.g the crash in 2008), bonds will help you to decrease the volatility in your portfolio.
Now, how do I think of all this allocation of assets?
Well, currently, I’m all in the stock market. Does this makes me a reckless cowboy? I don’t think so.
First of all, my stock allocation is based on two different levels. I buy ETFs, providing me with a wide variety of different companies with a decent dividend payout. Secondly, I invest in companies with roots so deep in our economy that regardless of a crash, the dividend payout will remain as it is. For those in doubt, check out the Dividend Aristocrats and to top that, the Dividend Kings.
Note: Don’t just randomly select companies from the aforementioned list and start buying stocks. Consider current valuation, market performance and many other parameters first. Besides that, I also think it’s important to think about future technologies and how our economy will involve in the next decades. I already covered this topic here.
Imagine a portfolio that produces enough dividend income to cover more than 100% of your costs? Even if there is a big drop in the stock market, your dividend income will provide enough coverage to last you each year. Excess cash at the end of the year you can easily safe and put towards more equity during a bear market. I’m trying to keep my current yield at 3.5 %. Find out why here.
So my asset allocation is at 100% and this won’t change in the nearby future. Once I’m close to “retirement”, I’ll perhaps adjust this allocation and maybe add 10% bonds.
More important are the extra defence/measures you can take against these volatile periods. My plan is to have at least 2 years of expenses in cash. This allows me to plan ahead. In years of economic growth, this will strengthen our cash cushion. In years of a severe recession, and worst case, dividend cuts, this allows us to not sell any stocks because we have money enough.
Do note that a stock portfolio big enough for you to live on the dividend income, takes a bit longer to accumulate. I rather work longer and live comfortably in the end than hope for the best after I retired. Another measure that I would like to plan, is at least one real estate property that provides us with a monthly income. Still working on this though…
Not that I’ve been posting consistently in the past weeks but forgive me for the upcoming period. In the next few days I’m travelling to Munich (working remotely) and afterwards to…