02 December 2005

In the stocks

Lately I've been reading a lot about investing.  It's not as if I have a ton of money sitting around, but I figure I might as well do the research now rather than later and find a good investment strategy I can stick with.  Stocks for the Long Run by Jeremy J. Siegel has taught me that the risk inherent in investing in stocks is vastly reduced when you keep them at least twenty years; A Random Walk Down Wall Street by Burton G. Malkiel has convinced me that low-cost index funds are likely to outperform actively-managed stock funds with less risk.  Modern Portfolio Theory and Investment Analysis by Edwin J. Elton et al. presents a fascinating quantitative theory for increasing return and decreasing risk by intelligently diversifying among investment classes, but the theory isn't simple to apply in practice.  One thing I don't want to do is try to pick individual stocks; it's just too risky.  I used to own shares of IBM when I worked there but I sold them as soon as the employee purchase plan allowed me to.

Here's my situation:  I'm 29 years old with no debt, a small income and a fairly high tolerance for risk.  My goal is long-term wealth accumulation.  Outside of a small emergency account with living expenses for six months, my current allocation is

63.2% total U.S. stock index (VTSMX)
  8.3% mid/small-cap U.S. stocks (VEXMX)
14.5% international stocks (VGTSX)
  9.0% intermediate-term corporate bonds (USIBX)
  2.9% real estate (VGSIX)
  2.1% gold (USAGX)

Right now I'm overweighted in mid/small-cap stocks as I slowly move funds from USAA to Vanguard.  My ideal allocation is roughly

65% total U.S. stock index
  3% mid/small-cap U.S. stocks
16% international stocks
  5% long-term corporate bonds
  5% intermediate-term corporate bonds
  3% real estate
  3% gold

Is this about right?  I wonder whether it makes sense to have any bond funds at all at my age—maybe I should just stick to stocks.  Opinions?


At 03 December, 2005 20:55, Blogger Jennifer said...

Ah, the never ending question of the properly diversified portfolio. At your age it's ok to experiment a bit with whatever investments that look good to you. Breaking into bonds is not a bad idea but it ties you up for a serious amount of time to recover the full amount of your investment and the potential you have for capital growth. You can find better avenues of growth for both short and long term investments. However, for stability there is no beating a high-rated bond (never below a BBB...please). I caveat this with the fact that I wanted to day trade and never finished my series 9 license therefore am not qualified nor licensed to give financial or investment advice.

At 03 December, 2005 22:29, Blogger Rob said...

Oh, right—I should have made it clear that I was talking about bond funds, not individual bonds.  Bond funds are diversified and a lot less risky and can be bought and sold at any time in any quantity, so the only real disadvantage is that the expected return is lower than stocks.  Sometimes I think there's no real advantage to bond funds at my age since I don't need the current income.

At 05 December, 2005 10:09, Blogger Jennifer said...

See, if I bothered to read things closely I would have known that. It's never a bad idea to have a well diversified portfolio.
Stocks are hit or miss sometimes and many of us remember the 90's crash so being overly weighted in them can be risky. And stocks themselves are inherently more risky. 2-5% of your total allocation might not be a bad idea in bond funds. Or you could consider dome DRIP's that may fluxuate more but will always be good. Exxon, Johnson & Johnson, P&G, and GE all have good programs right now.

At 05 December, 2005 14:00, Blogger Rob said...

Funny you mention Exxon and J&J—I held shares of them for quite a while along with AT&T, IBM and Lucent. Exxon and J&J actually did very well for me, but their market-beating returns were almost wiped out by the losses of IBM and especially AT&T and Lucent, which went in the f***ing toilet. Overall I ended up with returns barely better than the broad market but with much, much higher volatility. I sold them all, have pretty much stuck to low-cost index funds ever since and have been happier for it.

As for whether to keep my bond funds, you're right that keeping at least a small percentage may be smart. The reduction in risk is almost certainly worth the reduction in expected return. I guess it really comes down to investment horizon, and while I don't expect to touch my investments for at least twenty years, you never know.


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