The Allocation Situation

The financial services industry is really good at doling out blanket portfolio allocation directives, as Merrill Lynch did earlier this week. But just whom is that serving? Certainly not individual investors. Don't let yourself be compartmentalized. Each investor has his or her own goals and needs -- and they're different than the Street's.

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By Bob Bobala (TMF Bobala)
January 16, 2002

Merrill Lynch's (NYSE: MER) chief strategist recommended investors allocate more of their money to bonds instead of stocks earlier this week. As with any big call from the Wall Street powers, this one got considerable press, and who knows, it probably helped push stocks down farther.

So, should you readjust your portfolio allocation? Probably not. Anytime someone steps down off the high and mighty throne of Mt. Doom and gives a directive, investors are probably better off greeting it with skepticism.

Personally, I have never understood blanket portfolio allocation pronouncements. Now, I will be the first to admit that I am not the smartest guy. For a long time I rolled up all my money and put it in a little metal box underneath my bed beside my G.I. Joes and Hot Wheels -- then again, I was eight. But as I got older I became very anti-authoritarian. So maybe it's not common sense that makes me recoil when some guy in a suit is telling me what to do with my money. Maybe I just don't like the idea of cracking under the power of The Man.

But let's see what Merrill Lynch told us to do this week. Chief U.S. strategist Richard Bernstein said investors should lift their asset allocation in bonds to 30% from 20% and cut equity holdings to 50% from 60%. He kept Merrill's cash allocation recommendation at 20%.

Bernstein told some clients he was worried about stock valuations, saying they "now seem extreme." In fact, comparing growth rates to price-to-earnings ratios, he said stocks are more expensive than during 1987. Stocks prices are extreme now? One wonders where he was in 2000.

Merrill's valuation warning makes good sense. Valuation always matters -- how much, or how little I'll let Tom Jacobs try to answer. But what does that really have to do with asset allocation for the average investor? Are Merrill Lynch, Lehman Brothers, or Morgan Stanley Dean Witter really serving investors when they make these overarching statements? No. They might be serving themselves if you churn your account and they make money off the trading commissions. But taking their portfolio allocation advice is no better than taking it from David Lynch, the Bacon Brothers, or Huey, Dewey, Louie, and Donald.

At the core of The Motley Fool's mission is our belief that we are the best people to manage our own money. When Wall Street firms make "buy" recommendations or portfolio allocation recommendations, they're sure not doing it because they know our personal goals, hopes, and aspirations.

Should you put half of your money into stocks? Well, geeze, how can you ask me that kind of question? I'm not even as talented as the Bacon Brothers. Seriously, nobody can answer that question but you. You might consult with an unbiased professional like the ones available in our TMF Money Advisor service if you need help. But there are a few common-sense guidelines everybody can follow.

Don't put money you'll need in the next five years in stocks
Needless to say, your rent or mortgage payments are sacred. But heck, maybe you've got some real hang-ups and don't feel like a human being if you can't buy 10 pairs of Jordache jeans on the black market every year. Whatever floats your boat. But whether you're spending money on weird habits or putting it in stocks, make sure you have a rainy-day fund that you're comfortable with -- three months' worth, six months, a year, whatever you need. Emergencies happen: you put on weight, your jeans don't fit. Don't get caught with your pants down.

Don't assume bonds are better for you than stocks
Generally speaking, bonds are safer than stocks. But corporate bonds are not guaranteed. Bad things happen. Companies fail (heck, we even have "junk bond" status to indicate how risky bonds can be). Those considerations aside, remember that even quality bonds historically have underperformed stocks over the long haul. You risk losing out to inflation if you're not making enough off your retirement savings.

Don't try to run the table as you approach retirement
The closer you are to retirement, the more careful you should be with your money. Stocks are risky and volatile in the short-term. Even in retirement you will always need some of your money in stocks, but because you're living off your savings you'll need to move more of it to safer vehicles like bonds, money markets, or certificates of deposit.

Don't let your cash waste away under your bed matter how safe you think it is when it's guarded by your G.I. Joes. That also means don't let your cash savings waste away in a checking account that doesn't pay interest. Look for a short-term certificate of deposit or a money market account that pays something. Don't let other people use your money for free.

Now, each of these little kernels above can apply to anyone. Can Merrill Lynch's 50-30-20 split? Emphatically, no!

I'm in my early 30s with at least another 30 years to keep working -- probably more -- so given my tolerance for risk and my time horizon, I put all of my 401(k) savings in an S&P 500 index fund. I think that's the best way to grow my long-term wealth -- not to mention the least complicated. I'd have no idea what to do with a lot of bonds even if I chose to allocate 30% of my portfolio to them.

"There are basically three stimulants to the equity market: liquidity, valuation and sentiment," Merrill's Bernstein said this week. "It is difficult to see how any of these will provide the stock market with the necessary fillip to keep the recent rally intact."

That may be so, but long-term investors shouldn't be looking for fillip. They should be looking for the best businesses they can find and buying them if the price is right. The Motley Fool can help in that process, and perhaps that's why you've come here.

Either that or you're like me and you just don't want The Man telling you how to allocate your money.

Bob Bobala has issues with authority. He often makes his co-workers nervous by listening to the soundtrack to Office Space in Fool HQ. The Motley Fool has a disclosure policy and Bob owns an index fund like he already told you.