Investing and portfolio balancing

BY: STEVE BIKO

The stock market has been in a slump and so have other investments. Here is the safest assets allocation formula

Just how much pain can we handle as our stocks, mutual funds and other related securities tumble? This year has been a tough one for local investors, who have watched their investments lose value, with no clue on what to do. Not to mention plummeting confidence among the same class of investors in the stock market.

The bear market hammers us nearly every day with brutal reminders that stocks can be volatile, and so we may be realising that we overestimated our risk tolerance and put too much of our assets into the stock market; especially after the spectacular performances of past IPOs – save for Safaricom.

There are three factors instrumental in investing, be it in transport or the stock market. One that has especially stood out during these past couple of weeks is the issue of risk tolerance; which is always fundamental when it comes to investing anyway. Those of us with little stomach for the fluctuations of the financial markets, and whose primary objective is to preserve capital, should be in super-safe investments such as treasury bonds and bills, and insured savings accounts.

Investors hoping to see their money grow more rapidly than those conservative investments allow must be willing to assume more risk. (Some day the stock market will come back and hopefully outperform those conservative investments.)

Where you stand

If the current market plunge is hitting the pit of your stomach, if you’re suddenly having trouble sleeping, then you probably have too much exposure to stocks. Perhaps 80 percent of your investments are in equities, when a more appropriate percentage would be 60 percent.

It is natural to overestimate your risk tolerance. When the market is climbing, our desire to get in on the action tends to override risk aversion; we think we can accept more volatility to achieve higher returns. Risk tolerance changes every time the market moves, the lower the market goes, and suddenly everyone doesn’t want to be a risk-taker. The higher the market goes, the higher tolerance goes; clearly epitomising our lack of judgment as far as entry and exit strategies are concerned.

My advice, use this bear market to recognise your true risk tolerance. How much of a hit to your portfolio can you really stomach: 20 percent, 30 percent, 40 percent? Personally, the last couple of weeks have seen me ask friends and family for money to buy some stocks which I believe were at the best lows they will ever get, not to forget that I had taken a serious hit to my current portfolio and I had to restrategise.

How to allocate investments

You have to re-adjust your allocation now. Apply that “stomach-acid test” to set a long-term plan for allocating assets between stocks and investments that are less risky, including bonds and bills, and cash equivalents (money market funds, savings accounts, and fixed deposits.) A relatively conservative asset allocation mix is 40 percent stocks, 40 percent bonds, 20 percent cash. An aggressive mix would be closer to 80 percent stocks, 10 percent bonds, 10 percent cash.

“Set a course on your asset allocation that will guide you, and stick to the plan,” says Thomas Henske of Lenox Advisors. “If you start to deviate from the plan, if you make it more conservative on the lows then more aggressive on the highs, you’re doing the opposite of what you should do.”

Also, keep in mind that this bear market has likely already adjusted your asset allocation somewhat. A month ago, stocks may have comprised 70 percent of your portfolio. Their value now may be only 50 percent or less.

Sticking with your asset allocation may dictate that you continue investing in stocks, even during these scary times. If you are investing for college or retirement, and you are doing it on a monthly basis, do not stop. This is the way serious wealth is built over the long term. The best way to make money is to invest when it really, really hurts.

As you consider your asset allocation, make sure you are setting aside enough cash for at least a year of living expenses. Some financial experts recommend two years. Keeping enough cash at hand, even when the stock market is setting new records, will help you better stomach the next bear market.

source: smartbizafrica.com