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What should my Asset Allocation be?
This is the number one question we get in our (pretty much constantly flooded) inboxes. As this silly little blog continues to spiral out of control and our readership continues to climb, more and more people are writing to us and saying we’ve sparked something in them. A yearning, it seems, for life before it got so damned complicated, and so damned expensive!
And that’s AWESOME. The first step in the Millennial Revolution is standing up and refusing to be beholden to these annoying little truths that we’ve all come to accept. BS “truths” like “you HAVE to buy a house or you’re a loser.”
So of course the next step is to learn what to do with your money instead. We advocate a balanced, diversified Index Investing approach using low-cost ETFs that get rebalanced periodically. As we’ve said over and over again, this is the only way that the average Joe Shmoe can reliably and safely invest in the stock market. It beats 85% of active fund managers, and is championed by none other than Warren Buffet himself.
But one of the central pillars on Index Investing is to hold equities and fixed income in an asset allocation that makes sense for you. Remember the effect that asset allocation has on your portfolio performance. The higher your equity allocation, the higher your long-term returns will be, but at the cost of higher volatility.
As a result, academic research focuses on asset allocation as a function of age. Over 10-15 year periods of time, volatility becomes irrelevant. Remember that the S&P 500 has NEVER lost money over a 15-year period. So most studies recommend a higher equity exposure in your 20’s (~90% to 100%) and then gradually backing off as you get older.
Here’s the problem. In your 20’s, most people don’t know what the Hell they’re doing when it comes to Investing. We know we didn’t. We had to learn all that shit as we went, in the MIDDLE of the worst financial crisis of our generation no less. It was a bit like taking off in a plane and learning to fly it while it was in the air. Not fun.
So what’s a beginner investor to do? Should they go 90% equity like the papers say, or something more conservative like the 60%/40% split that we do?
This is a tough question to answer, as any financial advisor will say “it depends” and “there’s no one-size-fits-all answer.” And that’s true, but we here at the Millennial Revolution think we can do better.
Here’s the thing. While the cold, hard math indicates the single biggest determinant of long-term financial success is your asset allocation, in practice the single biggest determinant of long-term financial success is you, the investor. If you freak out and panic-sell at the first sign of loss, then it really doesn’t matter what your asset allocation is. You’re gonna get screwed and lose money during the next stock market crash (and it WILL crash).
So here’s our suggestion to those beginner Investors:
- First, pay off any and all high-interest debt. If you have any credit card debt whatsoever, investing makes no sense.
- Make sure you’re cash-flow-positive, meaning you’re saving money every month and your savings are growing, not shrinking.
- Carve out a small amount of your savings, say $5000 and invest it using low-cost Index ETFs or Index Funds such as the ones listed on CanadianCouchPotato. Use a portfolio allocation of 50% equity/50% fixed income.
- Leave the rest in a savings account and continue to sock money away into it.
The purpose of this exercise for the nervous first-time investor is to get comfortable with the idea of investing while limiting the amount of money that they could lose. Over time, either the stock market will either run ahead or (if you’re lucky) crash horribly, knocking your 50/50 asset allocation out of whack.
Why do I say “if you’re lucky” a stock market crash will happen? Because you’ll get to experience the deafening screeching noise the media makes each and every time the stock market crashes. They’ll say that “it’s different this time”, that the “world’s going to end as we know it”, and to “sell everything and run for the hills”. How do I know?
They say it every market crash.
The great thing about this strategy is that you’ll only have $5000 in the markets when this happens, so you’re less likely to freak out.
Then with the help of the soothing noises this blog will be emanating, you will be able to watch your portfolio go down in value calmly without worrying where your next meal is going to come from, figure out how many fixed income assets to sell to rebalance to your target 50/50 asset allocation, buy into the equity markets as they free-fall, then sit back and watch your portfolio rebound to a level higher than before.
We know this will happen because it happens every market crash. But only if you follow the rules of Index Investing and rebalance the way you’re supposed to. This simple strategy caused us to pull off a feat most of Wall Street couldn’t: If got us out of the Great Financial Crisis of 2008 without losing any money.
And after you make it out of your first crash, you’ll realize like we did that “hey, Investing isn’t that hard! Market crashes aren’t that scary!” At that point, you can up your equity allocation to something more aggressive, as well as deploy all that cash you’ve been saving this entire time.
The trick about investing is that there’s no real trick to it. The only thing you have to watch out for is your own fear forcing you to do the exact wrong thing at the exact wrong time. But what I believe is that fear comes from the unknown. The first time you ride a roller coaster, it’s scary because a part of you doesn’t know if you’ll get hurt. But when the ride’s over and you realize you’re OK, you’re not that scared the next time. Same with Investing.
And as usual, standard disclaimer: We are not licensed Financial Advisors and as such can’t legally recommend individual ETFs. The advice here is not based off fancy exams and certifications, but cold hard math and the fact that it allowed us to become the youngest retirees in Canada.
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