Asset Allocation: The Cornerstone of Your Investment Strategy

During the 2008 sell off, stock markets around the world plummeted on average by more than 35% while emerging markets indexes crashed more than 50% on average. Since many investors rely on the stock market to insure their retirement trough their pension funds or IRA, such an event had many disastrous results for those with heavy weight in equities in their portfolios. Was their asset allocation optimal? Possibly not.

But what is a proper asset allocation? This depends mostly on the age, risk tolerance, financial profile and life expectancy of the investor. A general rule of thumb says that 100 minus your age should represent your equity exposure in your retirement portfolio. For example, I'm 40 years old so the equity portion of my retirement portfolio should be around 60%. While this simple might not look very scientific, it does give an honest landmark.

Does a sound asset allocation matter so much? Wouldn't you be better off if you did some decent stock picking to do the work? What about market timing?

It might be a shock to you but according to a study made by Brinson, Singer, Beebowery in 1991, 91.5% of a portfolio volatility is explained by it's asset allocation. In other words, to make sure that your portfolio meets your risk tolerance and, consequently, your expectations of returns, you must concentrate the majority of your efforts on a sound asset allocation.

The volatility of a portfolio is explained by:

Asset allocation 91.5%

Stock selection 4.6%

Market timing 1.8%

Other factors 2.1%

Asset allocation got more complicated in the recent years because of the thousands of exchange traded funds (ETF) that offer a vast selection of asset classes such as:

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• Geographic areas (United States, Europe, Emerging markets, etc.)
• The different asset classes (Equities, Bonds, Real estate, Commodities, etc.)
• Different sectors (Energy, Financial Institutions, Healthcare, etc.)
• Different management styles (Value vs Growth)
• Etc.

With a choice so vast, a lot of investors could get lost very easily. Let's keep it simple; a complete diversification across the 2 major asset classes, bonds and stocks, could very be done with only 2 ETF's:

Equity portion of portfolio: Vanguard Total Stock Market ETF (VTI)

Bond portion of portfolio: iShares Barclays Aggregate Bond (AGG)

Just make sure you allocate properly your assets between stocks and bonds, and you should do fine in you investments.

Retirement Planning Booby Traps

Perhaps you haven't started investing regularly, or the amount you allocate is not enough to reach your retirement goals. Here are a few errors people make that can ruin otherwise good investment goals.

Booby Trap #1: Not viewing debt as negative investment earnings

If you are paying 18% interest on a credit card while earning 8% in an investment, that immediately places you in a 10% loss position. Moreover, where else can you get such a guarantee on your investment return, as you can by investing in your debt repayment? By paying off $5,000 over one year, you'll earn $900 risk-free and you won't have to pay that with after-tax dollars ever again.

Unsecured credit card debt can kill a once-healthy budget, while substantially reducing your income, and opportunities can suffer when your cash flow is crippled by debt. It is harder to solve the need for emergency cash if you are debt-ridden. Especially look at paying down debts that carry interest that cannot be written off as you are paying for both the principal and the interest with after-tax dollars.

Booby Trap #2: Not putting money away into an emergency fund

If an emergency arises you should be able to access a simple bank account to cover three to six months' worth of living expenses such as your rent or mortgage, food, debt repayment, car payments, etc. Failing to have this emergency reserve could, in very extreme cases lead to personal bankruptcy, or at a minimum foreclosure on your home or repossession of your car.

Booby Trap #3: Not assessing your retirement time horizon

You can analyze what you will need to invest annually, by running calculations such as those provided by a number of personal accounting software applications. Confer also with your advisor about how you can get there over your remaining employment years, by investing with a clear vision.

Booby Trap #4: Not investing regularly

The value of compound interest can never be underestimated. As a rule of thumb, your money when invested in a moderate plan can double every seven years. Even a simple investment of $25 per week can compound to nearly $20,000 in 10 years.

There are a number of other significant and potential land mines that can completely unhinge your retirement plans if you are not careful and do not plan correctly.

At the least, you should never trust your own judgment but should seek out the advice and guidance of a licensed financial planner. The amount you invest in their services can pave your way to a smooth and rewarding retirement.

Investment After Retirement

So, here it is, the big 'R'. You've spent a lifetime working, setting monies aside for investment after retirement. Now you're here! What to do? Most likely, your investment after retirement will consist of a pension (?), 401(K), or IRA and Social Security. Statistics say that the average savings in a retirement plan is $100,000.

After you've figured out your expenses, down sizing, making changes, you must figure income including a part time job if necessary. Once you have all of the particulars figured out you can give attention to how you are going to manage your investment after retirement.

Two of the main components of investing after retirement is to be conservative and use your funds in a tax advantage way. Too many retirees get foiled into thinking that they can invest in investments that promise high returns usually in a short period of time. Can you say Bernie Madoff? We have heard the saying, "if it's too good to be true, is usually is". We can't let greed be our guide.

Look for investment after retirement that will be relatively stable such as bonds, c.d., money market accounts and annuities. These are not sexy but will keep you safe. Remember, each of them has their own definitions. It's up to you to see what fits your risk tolerance. These should not have risks associated with them.

As far as taxes are concerned when investing after retirement, use funds that have the lowest tax liability. This strategy allows you to maintain your principal balance at as high a level as possible because the more taxes taken out of your withdrawals, the more principal you will have to withdraw to meet your expenses.

First investment after retirement is to withdraw any monies from a non retirement savings account. You've already paid taxes on these funds, so withdrawals will not cost you anything. Once these are depleted, go to your 401(K) or IRA. The best way to do this is to roll these funds into an annuity and start receiving a monthly income. You will enjoy a safe monthly income with guaranteed income while investing after retirement.

Remember, investments after retirement are probably more important to you than ever before. Consult a financial specialist, tax attorney.

Things to Consider in Early Retirement Planning

Retirement is something we need to consider while we still have the capability of working for it. It is something we need to invest into since this will be the one to carry us after we have given all the efforts we can during pre-retirement. Retirement is also something we need to plan as early as now.

Essentials of Early Retirement Planning

Planning for early retirement will not be that easy, this will need a budgeting skill since that will not be the only thing that comes to everybody's mind when money is on hand, the fact is, it barely comes into everyone else's mind. In order for us to save for our retirement we need to have a plan since plain saving will not help us go through it. Cutting a portion of each pay all by ourselves will surely end up to cheating, or skipping from one pay period to another. Plans will help us require ourselves to deduct a part of our earning but will first require us an early retirement planning.

How Much Do I Need to Retire?

In early retirement planning, the first thing we should ask ourselves is, "how much do I need to retire?" Projecting what life could offer in twenty-five to thirty years from now takes into the picture. Some suggestions include, investing on a business, a house or a car.

Good thing here comes retirement planning services that helps us get through the hardship of saving for an early retirement. These services offer different kind of plans, which we can choose in any way convenient to us. Upon knowing the different courses they offer in applying, financial planning for retirement comes in. We should take into consideration the different expenses between pre-retirement and retirement period. We all know that upon retirement, demands will be much lower but we need to choose a program that surely sustains the cost of living we used to have.

Also, another thing to consider is the monetary amount we are willing to sacrifice just for the sake early retirement planning. Remember that it is very important that you will have to be realistic in your estimated on the kind of expenses that you will have in your retirement. Your estimated are valued when you have figured out how much money you will need to save in order for you to afford happily on your retirement.

After taking into considerations all the above mentioned factors, that is the time to choose the perfect plan for you. A plan that you are able to acquire and will provide for you on the first day of your retirement up to the end.

Good Investment Options For Retirement: Dollar Cost Averaging

You've probably heard of dollar cost averaging (DCA) in the past. If not, it's an investment strategy taking the form of investing equal monetary amounts regularly and periodically over specific time periods (such as $100 monthly) in a particular investment. The main benefit: more shares are purchased when prices are low and fewer shares are purchased when prices are high.

We've put this strategy to the test. 1929 and 2008 were the worst years in the last century for equity markets so we thought it might be interesting to test DCA during these periods. How did DCA trough the worst two periods of the last century for equity markets? Our little study showed it produced impressive results. The following examples are for illustrative purpose and do not take into account dividends.

1929

Let's simulate the worst financial meltdown of the last century occurring at the end of the 1920's. The Dow Jones Industrial Average was at the time (and still is) the most followed stock index. Its descent started after it reached a high of 380 in August 1929. The downward spiral lasted 3 years until it touched bottom at 41.22 on July 1932, a whopping 89.2% lower. Most investors were decimated at the time and the Great Depression coincided with the collapse.

How would a monthly DCA invested in the Dow have done during the same time span? In mid 1934, almost 5 years after the top of 1929, the Dow was still at the very low level of 103 or -72.89% from the summit. However, at that specific time, a monthly DCA strategy started at the top of the market would have already recovered all the losses. That's right; while buy and hold investors would be left with a little more than a quarter of their initial investment, the DCA investor would already be breaking even after the worst financial meltdown of the century. Furthermore, it took the Dow Jones 25 years - in November 1954 - to reach once again its all time high of 380 of 1929.

Bottom line: DCA not only reduces the risk of equity investment, it also provides a boost in returns when markets turn on the upside after a decline.

2008

1929 is ancient history and most of us were not there to witness it. However, we do remember 2008 when a similar event took place. However, the 2008 meltdown compared to the one of 1929 wasn't as dramatic. But as you probably know, it did harm a lot of pension funds and retirement accounts. Also, almost all equity investors took a beating during this period.

Here is a quick recap of the events. In October 2007, the Dow Jones reached an all time high of 14164. When Lehman Brothers collapsed one year later, markets went down pretty fast in the following weeks. From the Dow level the day before Lehman's chapter 11 to the bottom of 6547 reached in early March 2009 - 5 months later - the Dow had lost 40% of its value. At this level, the Dow stood at a -53.5% from its all time high of October 2007. How would have done a monthly DCA strategy in such a context? While the Dow Jones stands today (November 2010) at 11193, it's still 20% lower from the all time high of October 2007. However, the monthly DCA investor, who started investing at the top of the market in October 2007, would already be up 9% on its invested capital. Furthermore, one year ago - October 2009 - our DCA investor recovered entirely its investment, the buy and hold approach would still be 25% under.

Bottom line: the 2008 meltdown was short lived for the DCA investor. Buy and hold investors however, still have important losses on their books and nobody know when the markets will reach their all time highs again.

Investing in Fixed Indexed Funds Can Restrict Your Capital Growth

Annuity investing is grabbing the headlines a lot these days as it seems to be an uncomplicated, systematic and lucrative investment opportunity, but only until the facts disguised are made public. So, here's a detailed guide for those who want to know what are the negatives of investing in a fixed indexed annuity before they buy into the words of their investment advisors and salespersons and gear-up to invest their money in a proposition beset with pitfalls and downsides. At the time of signing the final application for a fixed indexed annuity investment, often investors do not pay heed to the terms and conditions column, and pencil in their unique signatures, in turn, finalizing the contract. However, there are several negatives which are intentionally or unintentionally kept secret during the entire process. Let us take glimpse at the most important ones.

Unfolding Untold Story of Capped Returns

A fixed indexed annuity locks your principal amount for a long term, say 15 to 20 years. To top that, the returns earned are capped by the insurance companies; holding you back from having complete access to your own money. Certainly, the investment plan has been designed to fetch returns the way indexed markets do, however, some limitations have been imposed, cutting down the investors' profits. Moreover, a fixed indexed annuity is designed with emphasis on fund management, no matter how far capital growth is neglected.

Don't Ignore Taxation Trouble

Returns from a fixed indexed annuity are subject to income tax, unlike other indexed instruments that enjoy the benefit of paying much lower capital gains tax. This doesn't just confirm a higher rate of taxpaying; it also makes the nominee/survivor of the applicant liable to pay a part of the return from this scheme as income tax. However, this instrument enjoys deferred tax treatment; still the taxation policy takes it far away from being an ideal annuity instrument. Procedural Fees may Rob your Returns The procedural fee, operational cost and the fees of the fund manager collectively come out to be 1-3%, depending on the internal and some external factors. This further drops down the return for the investor and most of the time, the return underperforms indices.

Ouch! Does That Withdrawal Fee Hurt?

With a fixed index annuity, the investor is liable to bear a 5-10% early withdrawal fee for the amount beyond the set threshold or the maximum penalty-free annual amount. Once you know your withdrawal limit, and know how to stay within the brackets, things go smooth, but if the annual withdrawal amount crosses the limit, things might turn topsy-turvy. You might not be looking for a fixed indexed annuity, but chances are that it's been sold to you! If this is the case, someone who understands your present and future financial needs and can well plan out a scheme for you and your heirs can probably act as a shoe-horn in this situation, guiding you to mold your annuity and get at least something beneficial out of it.

Investing in Real Estate for Retirement

Why would one want to invest in real estate? All realtors will tell you: appreciation, cash flow and depreciation. Undoubtedly, over time, real properties will again rise in value. Even with the pounding that prices have taken, over the past 10 years (as August 2010), residential properties, on average (Case Shiller/SP 10 City data), outperformed the S&P 500 +47.3% for real estate, -30.9% for stocks! If you are saving for retirement, doesn't it make sense to diversify using investment properties?

If you have though of "downsizing" at or prior to retirement, consider the purchase of your retirement home now. After a professional adviser "crunches" the numbers, you might be amazed to see that buying a second home that can be rented can very well fit into your budget. In addition to rental income that you could receive, rental real estate also benefits from depreciation. This is a phantom expense that can turn a situation that is profitable from a cash flow perspective into a loss for tax purposes.

If you file jointly and your Adjusted Gross Income (AGI) is $100,000 or less, you may be able to write off up to $25,000 of your real estate losses against your income. That's a $6,250 reduction in taxes for those in the 25% tax bracket.

When you are ready to downsize, there could be great news for you. Unless current tax laws change, you may be able to sell your current residence and receive a tax exemption on up to $500,000 on the capital gains you realize. With that money, you can probably have enough to pay off the existing mortgage on the rental and move in to it. You might even have enough extra to provide you with extra income for the rest of your life.

One of the keys to success in the real estate market is understanding how the tax laws work in your favor. With proper planning, your cash flows can be managed and taxes reduced, making your purchases affordable.

Always be sure to check with your professional tax adviser before entering into complex investment transactions and tax laws are continually changing.

Gary Lewis' ideas incorporate more than 30 years working with investments including 20 years experience in the derivatives industry and 10 years as a fee-only comprehensive financial planner. He specializes in designing portfolios that meet the client's required rate of return with a minimum level of volatility. You can read his writings on financial markets at Asset Design Center.