My previous posts entitled “Questions and answers on the Philippine stock exchange” were followed up by another set of questions sent by the same person. The questions propounded also requires a lengthy answer and hence I am responding with three different blog posts on her recent questions.
In this post I am going to answer the question on Asset allocation strategy. The question is as follows:
“. . . We are given 1,000,000 pesos as the capitalization for the portfolio. We decided for an asset allocation of 65% stocks, 25% bonds, and 10% cash, based on a moderately aggressive risk tolerance.
Time horizon: 5 – 7 years
Expected return: 20% (??? is it practical?)
Objective: Capital preservation and growth
Strategy: Lump-sum or one-time investingJust wanna ask for your opinion of the above investment plan esp the allocation.”
My response on asset allocation strategy is as follows:
Dear Enji,
Asset allocation in a nutshell as defined by Wikipedia “ . . refers to how an investor distributes his or her investments among various classes of investment vehicles”
Asset allocation strategy actually depends on an investor’s profile. An investor’s profile refers to an individual’s preferences in investment decisions; such preference is of course dictated by various factors such as an investor’s objective and other social traits such as age, gender, income etc. That is why most mutual funds offer various type of fund products such as “Equity funds” (Investments in stocks only) “Balanced fund” (Investments in stocks and bonds) “Large-cap equity funds” (Invested only in large capital equities) etc. This is an attempt to offer products that cater to an individual investor’s taste.
A good book on personal asset allocation strategy I read before is entitled “Lifespan investing” by Clifford Pistolese. However I do not recommend that you buy a copy of the book because much of talks specifically about U.S stocks and the first few chapters deal with so much technical analysis. Lifespan investing shows the best allocation strategy to be followed depending on what age bracket a person is in his life. I wrote a short book review on the book. You can read it in my blog post entitled “The best time to invest – your lifetime” For those of you who are interested in getting a copy of “Life Span investing” get it here at my Guerilla Blogger eStore.
Anyway, in general the traditional rule of the thumb when it comes to asset allocation strategy is that you subtract your age from 100 and invest that percentage in stocks and the rest with bonds or cash. For example following this rule, the asset allocation strategy to be followed by a 20 year old should be 80 % in stocks and 20 % in cash and bonds, while a 40 year old should invest 60 % in stocks and 40 % in cash and bonds. This traditional asset allocation strategy makes age as the basis on how much “risk” an investor is willing to take.
Benjamin Graham however argues differently. He is known as the “Dean of Wall street”, principal mentor to Billionaire Warren Buffett and author of the book “The intelligent investor” (Widely considered by most financial experts as a classic and is dubbed as the “Bible of investing.”) Graham wrote in chapter 4 of his book that the intelligent investor should follow an asset allocation strategy of a minimum 25 % to a maximum of 75 % placed in bonds depending on an investor’s appetite for risk. It should be observed that Graham never mentions that asset allocation strategy should depend on age or any other factors as held by teachings on traditional asset allocation strategy.
The reason why Graham insists on following an asset allocation strategy of keeping a 25% minimum to a maximum of 75 % placed in bonds is in order to provide a “cushion” to give the investor the courage to keep the rest of his money in stocks even when stocks sink. Graham observes that most people stop investing when the stock market goes down. Not only that, most people seem to bail out into the safety of bonds and cash when the stock market gets battered. So having a cushion will keep investors from bailing out entirely out of the stock market whenever stocks fare badly.
Jason Zweig, writes in a commentary about Graham’s asset allocation strategy that “The very heart of this approach is to replace guesswork with discipline.” Investing takes a lot of discipline and the proper temperament. Adjusting the percentage devoted to bonds will depend on an investor’s appetite for risk and changes in the circumstances of his life.
With regards to “Cash” most financial experts agree that the rule of the thumb is to keep 6 months worth of Salary for “emergency” purposes. That way you are not forced to sell your stock positions even at a lost because you badly need the money.
Based on the above arguments, I strongly support your Asset allocation of 65 % stocks 25% bonds and 10% cash.
However if the 1,000,000.00 you are talking about is all devoted to “investments” then make it 75 % stocks and 25 % bonds. This is of course is based on your given investor’s profile of one that is has a “moderately aggressive risk for tolerance.”
My personal asset allocation strategy is to devote 100 % of my investments to stocks. As Warren Buffett quipped when prompted to invest in real estate by a friend, “Why should I buy real estate when the stock market is so easy?” 🙂
However I wouldn’t advice that all people should follow my asset allocation strategy. I am only giving this advice to people who understand the stock market and who knows exactly how to invest in stocks.
I will answer the question on the “practicality of the 20 % return” on my next posts.
Till then,
Atty. Zigfred Diaz
The Guerilla investor:-)
P.S: For those of you who want to get a copy of “The intelligent investor” by Benjamin Graham get it at my Guerilla blogger eStore.
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Looks like Ben Graham had a default 50:50 for bonds/equities for a defensive investor; and 75:25 for enterprising investor when equities market starts falling. the reverse would be for a roaring bull market.
Graham also advocates diversification.
The present-day Buffett actually has a concentrated shares, which means that he carries no more than 20 equities on his portfolio. There is no rule for this one. Munger, his vice-Chairman has 3-4 equities.
The main argument is that you can monitor/know your business if there are few. Buffett would also encourage that if you are sure with a particular stock, you place 20% of your net worth on it.
Just my two cents.
Xuzhu: Yep Buffett deviated from Graham’s teachings when it came to diversification. In this particular arena, Buffett is following the principles set forth by John Meynard Keyenes and Philip Fisher. That’s why Buffett used to say “I’m 85 % Graham, 15 % Fisher” But I think he is actually 50 % Graham and 50 % Fisher-Keynes-Williams and of course Munger.” Anyway, I’ll write about this in another posts.
“The main argument is that you can monitor/know your business if there are few. Buffett would also encourage that if you are sure with a particular stock, you place 20% of your net worth on it.” Yep, I agree ! Two thumbs up !