This volatile market environment has challenged even the most expert investors. Lots of market professionals have taken big hits, thanks to the depth and breadth of the market's declines. Few stocks have held up well, while value investors counting on rebounds from beaten-down blue-chip financials like General Electric (NYSE:GE) and Bank of America (NYSE:BAC) have seen nothing but further losses.
Given how hard it is to invest well, relying on some easy-to-understand basic rules for your investing can sound extremely tempting. But before you bet your life savings on a rule of thumb, you need to understand that simple rules can oversimplify complicated situations -- and potentially cause losses that you could have avoided with a little more thought.
The (too) basics of asset allocation
For example, rather than dealing with all the complexities of researching and picking individual stocks, lots of investors use very simple asset allocation rules to invest their money. For instance, one rule of thumb says that younger investors should put nearly all of their money into stocks, while older investors should gradually cut back on their allocations to risky investments in favor of safer plays like bonds and bank CDs.
You can even get mutual fund companies to do that work for you, through a one-stop shopping option known as target allocation funds. Target funds most often are tailored toward those aiming to retire in a certain year. If you still have plenty of time to go before retirement, these funds stay mostly invested in stocks -- but as your retirement date approaches, the fund manager starts shifting those assets into bonds and cash.
Alternatively, you can do a very simple allocation on your own. Just by using a couple of index funds -- a stock index and a bond index -- you can easily tailor your portfolio to whatever mix of bonds and stocks you like.
Know the specifics
As easy as those options sound, though, the best asset allocation strategy requires a little more thought. A one-size-fits-all philosophy most typically won't fit well with your finances. After all:
- Not all stocks are equally risky.
- Indexes or target funds may not buy the particular stocks you like.
- A target fund may take more risk than you're prepared for.
These shortcomings can end up causing much more damage to your portfolio than you might expect.
The (pretty) simple solution
That doesn't mean, though, that those simple rules are useless. It just means that you have to refine them a little bit, and better apply them to your own particular situation. For instance, if you want your asset allocation to reflect your needs, personalize your portfolio. Here are some pointers:
- Think income. Dividend yields on stocks are fairly attractive now, so even a heavy stock allocation can pay reasonably high income. But if you want even more income, focusing on stocks with particularly high yields, such as Coca-Cola (NYSE:KO) and 3M (NYSE:MMM), can work out a lot better than a plain-vanilla portfolio.
- Go global. Basic asset allocation funds tend to include a huge allocation to domestic stocks. If, however, you believe that overseas economies will outperform the U.S. for the immediate future and that companies like Petroleo Brasileiro (NYSE:PBR) and Baidu.com (NASDAQ:BIDU) will do better than their American rivals, then you might not be satisfied with what your target fund gives you.
- Be comfortable with risk. If you want more risk than an ordinary asset allocation would give you, you can double-up on higher-return small-cap stocks like Blackboard (NASDAQ:BBBB). On the other hand, safer stocks with a bigger margin of safety can help cushion your portfolio from at least some of the volatility you'll see from more speculative investments.
With all the mutual funds and exchange-traded funds available to help you, it's easy to customize your portfolio to meet your needs. All it takes is the awareness that you need to do it -- and a little effort.
Want help with that? Asset allocation is the lynchpin of Fool retirement expert Robert Brokamp's investing philosophy, and something he talks about a lot in his Rule Your Retirement newsletter. Check out the January issue for some asset allocation insight, both from Robert and from other financial experts. And if you're not already a subscriber, don't worry -- it's easy to sneak a peek free at the current issue and all past ones with a 30-day trial.
For more on getting your long-term investing on track, read about:
- The ultimate safe-haven investment.
- 5 stocks you need to avoid.
- The only way you should buy stocks now.
