In the last blog entry yesterday, I proposed a simple seven ETF portfolio that generated a Return/Uncertainty ratio of 0.57. This is very close to our baseline of something greater than 0.60. In the following portfolio, assume one sold off the 10% holding in VTI and shifted those assets over to the ultra-short SDS ETF. There needs to be some reason for making the shift, but for now, assume those reasons are valid. Under today's conditions, what does such a portfolio look like. We call this hedging.
When we get up this high in the numbering system, to use the word Rule sounds a tad stiff or rigid. It might go down a bit easier if one were to think of Rule #4 as a suggestion or guideline. Regardless, this next idea builds off Rule #3 of building a portfolio. In the first two rules we determined the importance of saving and staying disciplined with our program. Now we need to know what to do with the money we have saved. Portfolio planning is the next step and in this Rule #4 or suggestion we get a bit more specific. Keep in mind that after saving, asset allocation is the most important decision one will make in preparation for retirement. At least it is one we can control. I only wish I had known this forty years ago.
1) The asset allocation plan will take into consideration where you are in your life span. As suggested many times on this blog, to help in the asset allocation planning process, investors should take the Risk Capacity Survey over on the http://www.ifa.com web site.
2) Understand your tolerance for risk. The Risk Capacity Survey will help. Don’t be over confident and if you think you are leaning in that direction, remember 2000 – 2003 and 2008. Black Swan events happen more frequently than the laws of probability would dictate.
3) Know your financial situation. If you built up a nice nest egg, do not throw it away by investing on the edge of your risk tolerance. We attempt to take this into account as we build portfolios. Platinum members have access to excellent examples. Don’t push your luck. In the process of considering your financial situation, do you have money set aside for a job layoff? Is the house paid for or can you pay your rent? Are credit cards down to a zero balance at the end of the month? Are you properly insured? As you get older, do you really need that life insurance policy? Think through your financial situation as you contemplate putting together an asset allocation plan.
At this point, we have a saving plan in operation and we are committed to sticking with it. We are paying down debt or we have no high interest debt. We are, with Rule #4, moving into the fun areas of investing.
Photograph: Santorini, Greece