Cash, Bonds, and Equities: How much of your funds should you allocate to these three?
Each Wednesday, we publish articles about great investing tips with hopes to help get you on the path towards true wealth and value creation. Today, we’ll focus on the importance of balancing your investment strategies. Keep reading to know why you should avoid putting ALL of your savings into one asset class only.
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Cash, Bonds, and Equities: How much of your funds should you allocate to these three? In our past “The Independent Investor” articles, we talked about two of the disciplines of the greatest investors in the world. These are:
Did you know that while these values are great on their own, each of them also play a significant role in helping you master the other disciplines in investing? For example: You wouldn’t successfully maximize your investment wealth unless you learn how to control your emotions. These disciplines go hand-in-hand in making you a wiser and better investor. Today, we’ll talk about the third investing discipline that enabled some of the world’s billionaire investors to succeed in their strategies. This principle requires knowledge and mastery of the first two disciplines we wrote about earlier this year. Balancing Your Investing Strategies to Fit Your Lifestyle Investors know that business ownership is important… and one way they become an owner of businesses is by becoming an owner of stocks of various high-performing companies. However, as an old Latin proverb says, “Too much of anything is bad.” While it’s true that business ownership is important and a great stepping stone for achieving long-term financial stability, it’s also not prudent to simply put ALL of your savings into stocks alone. Sure, stock ownership pays off best in the long run… but the thing is, this type of investment also has numerous ups and downs along the way. Oh no… are you changing your mind now about investing in the stock market? Don’t! As long as you have a goal and commitment to maximize your wealth and an ability to put your emotions aside, you will determine the right strategy, combination, and plan for your assets and investments.
There are three choices when allocating your funds:
Let’s discuss them one by one… Cash/Cash-like Savings This asset class refers to putting your money into banks for immediate use. This includes savings accounts, certificates of deposits (CDs), and money market securities. Here’s the thing: While cash/cash-like savings are great for storing money that you will need to spend in the near future, they are not great in generating wealth in the long run. Why? These accounts almost never pay more than the rate of inflation! For instance: If the bank is paying you 2% interest, the inflation rate is likely 3% or higher. If the bank is paying you 5% interest, the inflation rate is likely 7% or higher. While this may seem like you made money at the end of the year or your savings may have increased in value, the reality is you can only buy less stuff because of inflation. The key takeaway from this section? Savings accounts are actually losing accounts. The only benefit they have is that they are unlikely to fall much in prices. Bonds This asset class means loaning some of your money to companies or governments then after a longer, fixed period of time, they pay you back with interest. Bonds are slightly better compared to cash/cash-like savings because they often pay an interest rate above inflation and generally preserve your capital. However, the amount companies or governments pay you over inflation still pales in comparison to the return that stocks provide over long periods of time. So, if you’re looking for an investment vehicle that would generate great returns in the long term, bonds are also not the way to go. Equities This asset class refers to giving money to companies in exchange for owning a percentage of the current assets and future profits of those businesses. Equities are also known as stocks. According to Peter Lynch, former Manager of the Magellan Fund at Fidelity Investments: “If you hope to have more money tomorrow than you have today, you’ve got to put a chunk of your assets into stocks.” “Sooner or later, a portfolio of stocks or stock mutual funds will turn out to be a lot more valuable than a portfolio of bonds, CDs, or money market funds.” Simply said, equities or stocks are the only good choice for generating wealth and building your investments over the long term. … but take note of the keyword from Lynch’s statements: CHUNK—meaning, you just have to allot a portion of your fund to equities, NOT your entire fund. Also, we’re not saying cash/cash-like savings and bonds are bad asset classes. What we’re saying is these two are only applicable to a particular, short-term spending need—cash that needs to be spent immediately or in the near future. Over long periods of time, equities or stocks outperform other asset classes in investing. This shows that clearly, there is some need for cash/cash-like savings and bonds, but as much as possible, equities and business ownership must be maximized. Coming up with a strategy for balancing your funds among these three asset classes is known as asset allocation. … and according to Professor Joel Litman, CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, this is one of the most important decisions in your investing strategy. As an investor, you will have to spend a fraction of your time allocating your assets. The answer of how much to invest in each class depends on YOU. It should be specific to your lifestyle, spending needs, etc. Doing this requires upfront time and thought with your own periodic review. The good thing is the choices are not that difficult… but since they are specific to you, no one else can tell you the amount or percentage to invest in stocks or to keep in cash/cash-like savings or bonds. As Walter Schloss, a proponent of the Benjamin Graham School of Value Investing, said: “When it comes to investing, my suggestion is to first understand your strengths and weaknesses, then devise a simple strategy so that you can sleep at night!” Apply this investing discipline the next time you’re planning to allocate your assets! With a concrete goal and ability to control your emotions, you’ll identify the most suitable strategies for your investments and balance your asset allocations to fit your lifestyle. Hope you’ve found this week’s insights interesting and helpful. Follow us on LinkedIn. Stay tuned for next Wednesday’s The Independent Investor! Reading is an important activity and skill. Learn more about the benefits of reading in investing in next week’s article! |
