We at The Motley Fool get a lot of email. As you might guess, a lot of it has to do with get-rich-quick schemes ("Be the last remaining apprentice and run one of my businesses!"), pleas from former government officials in third-world countries ("I've stashed billions in banks around the world, but I'm stuck in a spider hole -- help me and I'll help you!"), and enlarging one's body parts ("Grow bigger feet and hands today!").
But some emails we receive are from Fool readers asking questions. Here's one that made it through our spam filters and into our inbox: "What's the best method of asset allocation? Is there a formula?"
An excellent, and common, question. So here's our response.
First of all, what is asset allocation? Basically it's a fancy and Wise term that refers to how much of your money you've got in the stock market, as opposed to cash, bonds, or other stuff. The Foolish line on this, which we repeat often, is that you shouldn't put anything in the stock market that you will need in the next five years, and preferably not in the next 10 years or longer. For example, a Fool planning on making a down payment on a house in a couple of years should not put money earmarked for this into the stock market.
In addition, Fools generally don't invest in the stock market when they are paying off non-tax-deductible debt, especially high-interest credit card debt. Stock market investments can wait until that high-interest debt is eliminated. In many cases, it makes sense to sell stock to eliminate the high-interest debt.
That's Foolish (i.e., good) advice. However, when it comes to asset allocation, it may not be what you'll hear from the Wise (i.e., Wall Street "pros"). First off, your full-service broker may not even ask about your high-interest debt (after all, he doesn't make money from encouraging you to pay off your credit card). Instead, he'll recommend that you have 60% of your portfolio in stocks, 30% in bonds, and 10% in cash. In four months, though, it's time to go 40% stocks, 35% bonds, and 25% cash. Unless you've recently come across some new cash, there's only one way that you can follow his new allocation strategy -- sell something that you already own and buy something new in its place.
You can call us Fools, but we think much of the hullabaloo on Wall Street about asset allocation is driven by a vested interest in generating more transactions from customers, more commission payments, and more profits for the firm. When you reason through the consequences of frequently redefining your portfolio allocation, we think you'll agree that if you truly are a long-term investor -- if you have more than eight to 10 years to invest -- you should stick with a single, low-cost allocation strategy: 100% in stocks (after setting aside your emergency cash stash of three to six months of living expenses).
Once you've gotten past the investing "hurdles" of big purchases and debt, there is still at least one more question that needs to be addressed: How much of my "investable income" should I be putting in the stock market? One way of thinking about this is (assuming you have a sufficient timeline) "as much in stocks as you can stomach." This makes sense since equities have performed so much better than other investments over long periods of time.
To sum up:
- Get out of debt (try our free online seminar).
- Keep money you'll need in the next five years, and your emergency fund, in safe, liquid investments (visit our Savings Center for worthy candidates).
- Put the rest in stocks, at least as much as you can stand.
- Send us your money and we'll explain how you can get rich quick by enlarging the body parts of third-world ex-dictators (just kidding).
