Misconceptions are out, TIMETABLE is in! Here's a way to know how to properly allocate your funds…
In a past “The Independent Investor” article, we discussed the third discipline of the giants of investing, which is about balancing your investing strategies to fit your lifestyle.
We also talked about the 3 asset classes where you can allocate your funds:
- Cash/Cash-like Savings
- Bonds
- Equities/Stocks
According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, knowing how to allocate your funds accordingly is one of the most important decisions you’ll have to make as an investor. This will help you maximize your wealth both in the short term and long term.
Today, let’s focus on another aspect of asset allocation. It’s about…
The common misconceptions associated with the asset classes mentioned above!
If you observe the changes in the stock market closely, you’ll probably notice that what you read or hear from the news oftentimes doesn’t reflect actual trends.
In fact, many commonly accepted investing myths and misconceptions, as well as sensationalized financial news, have become pervasive that they affect how investors choose to invest.
Are you aware of these common misconceptions in investing?
Let’s take a look at some of them and debunk them one by one…
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Volatility - Why Stocks Sometimes Get a Bad Rap
According to Professor Litman, it’s unfortunate that some investors associate stocks with volatility… and volatility, with risk of loss.
He says while it’s true that stocks are more volatile than cash/cash-like savings and bonds, over the long run, this asset class outperforms the other two.
Here’s what some of the world’s greatest investors have to say about stocks and volatility:
“He (the true investor) can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times.”
- Warren Buffett, Chairman and CEO of Berkshire Hathaway
“We steer clear of the foolhardy academic definition of risk and volatility, recognizing, instead, that volatility is a welcome creator of opportunity.”
- Seth Klarman, Chief Executive and Portfolio Manager of the Baupost Group
“How can professors spread this [nonsense that a stock’s volatility is a measure or risk]? I’ve been waiting for this craziness to end for decades. It’s been dented, but it’s still out there.”
- Charlie Munger, Vice Chairman of Berkshire Hathaway
“Because we focus on value instead of price, we do not consider short-term stock market volatility a risk.”
- Chris Davis, Chairman and Portfolio Manager of Davis Funds
Observe the statements above. While these great investors used different words, the main point of their messages is the same:
As an investor, you shouldn’t be afraid of stock market volatility.
Here’s what you should do instead: Always keep in mind that money that needs to be spent in the near future shouldn’t be invested in stocks. So, if you’re preparing for a down payment to buy a house within 1 year, don’t put that money in the stock market. There simply isn’t enough time.
Meanwhile, if you’re planning to set aside money for your retirement in 20 years, there is no better place for that amount to be in than the stock market.
The bottom line?
To avoid associating stocks with volatility and risks, allocate your funds wisely. The right strategy comes from determining how much you can possibly put into equities based on the amounts you have to put into cash/cash-like savings or bonds.
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Aggressive and Conservative Investing
There is a misconception that stocks are risky and bonds are safe. Another poor piece of advice is if you’re an aggressive investor, you ought to buy equities. If you’re a conservative investor, you ought to buy bonds.
There’s more!
Another terrible advice spreading around the financial industry is if you’re young, you should buy equities. If you’re old, you should buy bonds.
Here’s the thing: If you define risk more specifically as the risk that you could lose money, then know that cash/cash-like savings and bonds are bad for wealth creation, especially if your goal is for the long term.
Remember: Savings accounts are actually losing accounts. They almost never pay an interest rate more than the rate of inflation. The only benefit they have is they’re unlikely to fall much in prices.
Meanwhile, bonds aren’t best for long-term financial goals either. While they pay an interest rate above inflation and generally preserve your capital, the amount you get still pales in comparison to the return that stocks provide in the long run.
Oh, and another thing!
It doesn’t matter what your age is as an investor. If you’re 60 years old and you know you won’t be spending your money until you’re 75, that amount ought to be in stocks.
On the other hand, if you’re 25 years old and you need to spend money for a baby you’ll be having in 9 months, that amount should be placed in cash/cash-like savings.
As Professor Litman said,
“It’s not age that matters. It’s your particular spending needs and life choices.”
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Investing in Other Assets
At this point, you might be wondering:
“What about other assets such as real estate, gold, art, or bitcoin?”
Professor Litman says the core of your investing strategy should still remain with balancing cash/cash-like savings, bonds, and stocks. Don’t focus on the assets mentioned above because they pose serious concerns that can negatively impact your portfolio.
Besides, the goal is an emotion-free, comfortable investment strategy that maximizes your wealth.
… but how can you know if the amount you put into savings accounts, bonds, or stocks is just right for you?
That’s where learning how to build your own timetable comes in!
The timetable method comes in the form of worksheets, articles, videos, and periodic community conference calls. These materials help you break your spending needs into “time buckets,” which are focused on the asset class that is right for you at that period.
Once your timetable is finalized, you have the basic plan for long-term, emotion-free investing.
… and when that happens, congratulations! You’re one step closer to achieving your financial goals and through this method, you’ll also have an added layer to prevent yourself from easily falling into the trap of the misconceptions we discussed.
Take note of these common myths in investing and ways to combat them!
By having knowledge about how you can allocate your funds wisely and creating your own timetable, you will invest properly and enhance your portfolio.
What’s more?
Applying these tips on investing will not only enable you to maximize wealth in the short term, but also achieve financial stability in the long term.
May this topic help you have an effective, thought-out, and emotion-free investing strategy!
“A good investment strategy relies not on excitement or hope for unrealistic gains. It is simply a discipline in properly balancing one’s investments across cash instruments, bonds, and equities.”
- Professor Joel Litman
Hope you’ve found this week’s insights interesting and helpful.
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Stay tuned for next Wednesday’s The Independent Investor!
In 1939, there was a Tennessee investor who, right after Nazi ruler Adolf Hitler invaded Poland, called his broker and told him to buy USD 100 worth of every stock in the US market that had dropped to less than USD 1.
Learn more about the importance of being a contrarian investor in next week’s article!
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