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Part 2: Investment Planning Thumbnail

Part 2: Investment Planning

Austin Colby, CFP®, MBA

A few years ago, I watched my then 6-year-old skip gracefully out the front door, across our porch, and finally into our chicken coop. She glided through that door with a twirl—naturally—and emerged a few minutes later with her basket crowded with the freshest eggs imaginable. Her return trip began with the same leap into a skip, but a slight misstep on the porch forced her off-balance for barely a moment…. but it was enough for those precious eggs to spill from the basket onto the porch.

She looked at me first in disbelief, but quickly melted into complete sorrow and heartache while rushing into my arms. As I held her and assured her it was okay, I glanced at the mess on the porch. For the first time in my life, I truly appreciated the phrase, “Don’t put all of your eggs in one basket.”

While the incident that crystalized that philosophy was not a fond one, it never fails to bring a smile to my face when applied to investment planning.

Asset allocation (i.e., not putting all your eggs in one basket) is an investment strategy that balances short-term risk and reward by spreading available investment dollars across several categories.

When building client portfolios, we start with this process of asset allocation. Broadly speaking, we break portfolios into two major categories: stocks and bonds. For certain portfolios, cash is also used as an asset class.

The equity (stocks) portion is the growth engine of the portfolio. Over the past 30 years, the U.S. stock market has earned an average annual rate of return of just over 10%. Of course, with that reward comes risk. In any given year, it is not uncommon to see rates of return ranging from -5% up to 25%.

The fixed income (bonds) portion is used to mitigate the volatility brought on by the equity piece. The bonds also serve as a holding place for future known, systematic withdrawal needs.

For clients in accumulation mode (who are actively adding to their portfolio with several years before income needs will begin), we want as much growth as possible. Because money is being regularly added to the portfolio, the client will naturally buy the dips along the way. As clients get closer to needing regular withdrawals from the portfolio, we start to shift weight from the equity to fixed income.

For clients in distribution mode (who are no longer actively adding to the portfolio, within a few years of needing income from the portfolio, or regularly taking withdrawals), we use the fixed income portion to protect years of future known withdrawals from the short-term stock market volatility.  

If a client has a $2,000,000 portfolio and needs monthly withdrawals of $5,000, then one year’s worth of withdrawals would be $60,000, five years of withdrawals equals $300,000, and 10 years’ worth equals $600,000.  Depending on that client’s age and risk tolerance, we would keep $300,000 - $600,000 of the portfolio in fixed income holdings to ensure the client has 5-10 years of future withdrawals protected from any potential stock market fluctuations.

Asset allocation is a proven strategy that helps smooth out the long-term ride on the investment rollercoaster. By definition of diversification, it will rarely win the race in a one-year rate of return contest.

However, our main concern is not one-year portfolio returns, but whether you are on track to accomplish your long-term goals. As it relates to investment planning, any 10+-year period shows that asset allocation provides a very confident “yes” to that question.