It's the start of a new year and an excellent time to reevaluate your financial objectives and strategy. With the Standard and Poors 500 Index up 28.7% in 2003, investors should take a few moments to tally up their holdings in each of the various asset classes and see where they stand relative to their sector targets and overall objectives. With stocks outperforming bonds by such a large margin last year, it's easy to see how portfolio allocations over the course of the year could have drifted outside target ranges.
Revisit Your Financial Objectives and Risk Profile
The first step in an annual review and asset reallocation process should be a review of your financial objectives and risk profile. Have your objectives or your ability to tolerate risk changed over the last year? If the answer is yes, or you've never given it much thought, now would be a good time to consider just what your long-term goals are for your financial assets and how much volatility you are willing to bear to pursue them. The idea is to determine target ranges for each class of assets you intend to use. For most investors that means equities (common stock), fixed income (bonds), and cash equivalents (money markets). This is typically referred to as one's "asset allocation." Larger investors at times add supplemental asset classes to this mix, for example: venture capital, real estate, hedge funds, etc.
A good question to ask yourself when attempting to figure out your financial objectives is:
The answer to this question is generally fairly obvious. Risk tolerance, on the other hand, is much more difficult to quantify.
When discussing risk (or volatility, as it is typically defined), I like to start by getting clients to consider the time horizon over which their objectives are to be reached. This may or may not be the same as their life expectancy. If the goal is to build assets to leave a legacy for one's beneficiaries, the time horizon should be tied to the beneficiaries' needs; this may allow the portfolio to accept a considerably higher level of risk, even in the portfolios of older investors.
Alternatively, if the objective is a comfortable retirement beginning within the next five years, a much less volatile, more conservative allocation would be recommended.
Determine an Appropriate Asset Allocation
Once you have given consideration to your ultimate financial goals and come to grips with the level of portfolio risk or volatility you are willing to live with, you can then determine or redefine your asset allocation strategy, setting target ranges for each of the asset classes you plan to use.
The following additional considerations might help determine an appropriate asset allocation:
A typical "balanced" asset allocation strategy might look like the following:
Strategically reallocating your portfolio holdings periodically - - maintaining target asset class ranges - - will allow you to manage your total risk exposure. For example, let's assume that the "target" allocation of your combined portfolio is 50%-60% in stocks, and you currently hold a 55% position. If, over a period of time (however often you choose to reallocate), stocks rise relative to bonds for the period, bringing their weight in the combined portfolio up above the target maximum of 60% to, let's say 70%, a strategic asset allocation strategy would prompt you to reallocate your portfolio. You would sell stock, buy bonds, and thus bring your weighting in stocks back down to 55% of your total portfolio. You would thus be maintaining your desired risk level and effectively "selling high." The opposite would be true of a weak stock market, where equity positions would be bought to bring the allocation to stocks back up to 55%. By doing this consistently over time, you are able to maximize portfolio return (by definition you wind up "buying low" and "selling high" consistently over time) while effectively managing your portfolio risk.
Having the discipline to adhere to a well thought-out, tax-efficient asset allocation strategy over long periods of time is probably the single most important aspect of a successful investment strategy.
Marc J. Lane Investment Management, Inc. stands ready to assist you in developing - - and implementing - - your optimal asset allocation.
Our best wishes to you and your family for a Happy and Healthy 2004.
J. Brad Strom is a Senior Vice President and a Portfolio Manager of Marc J. Lane Investment Management, Inc., the registered investment advisory affiliate of The Law Offices of Marc J. Lane, a Professional Corporation. Mr. Strom earned his Master's degree in Finance from DePaul University's Graduate School of Business in 1993 and his Chartered Financial Analyst designation in 1994. He is a member of the Investment Analysts Society of Chicago and the Association for Investment Management and Research. E-mail: firstname.lastname@example.org
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.