Your Most Important Investment Decision

Add comment March 10th, 2008

  Amy L. Barrett, MBA, CFA, CFP®, CDFA™ 

My previous blog discussed the importance of identifying investment goals.  A carefully planned goal is similar to the destination on a trip: the place that we want to reach.  On a road trip, the car is the tool to get us there while in the financial world, the tool is the investments.   

The most important financial decision affecting long-term investment results is the choice of stock-to-bond ratio of a portfolio.  A simple example will help to illustrate the stock-to-bond ratio concept.  An investor with $100,000 can choose to purchase $100, 000 of stocks or $100,000 of bonds.  Alternatively, the investor could hold a percentage of stocks and bonds.  For example, he could buy 50% of each: $50,000 stocks and $50,000 bonds.  The percentage of stocks to bonds (50% stocks to 50% bonds) is known as asset allocation.  The ratio is the most critical long-term influence on portfolio results because of the return difference between stocks and bonds.  Where a bulldozer (think of bonds) could get to your destination, the trip might be slow and steady.  On the other hand, the racecar (stocks), will get your there sooner.  Historically, stocks (S&P 500) have had an investment return of 10.4% per year while bonds (U.S. Long-term Treasuries) had returned 8.5% per year.  The implication is that the greater percentage of stocks, the higher expected ending wealth.  Bonds lower the potential return of the portfolio.  

How do to you choose the ratio of stocks-to-bonds?  At Savant, we like to think of the stock-to-bond ratio choice as an eat more/sleep more choice.  The more stocks in the portfolio, the higher the expected return, thus you can eat more in the end.  The sleep more choice is one of physiological comfort where you are OK with the losses in bad times. One of the advantages of working with a financial advisor is their skill in helping identify your portfolio choice.  Just as a good car salesperson can help you get the best auto for your cross-country trip, a skilled advisor can assist with the asset allocation choice.  

Amy L. Barrett MBA, CFA, CFP®, CDFA™ is a financial advisor, specializing in investment and divorce planning issues, with Savant Capital Management, Inc., Rockford, IL  815-227-0300