Financial Planning 101: Part 9
Developing an Investment Strategy

by Gerald Townsend, Financial Editor
September 2009

Last month’s article in the Financial Planning 101 Series discussed investment fundamentals, the difference between "loaner" and "owner" assets and the necessity of balancing the competing desires of wanting your money to grow while also keeping it safe. This month we look at the process of developing an investment strategy and constructing a portfolio to accomplish that balance

Let’s first distinguish between "risk tolerance" and "risk capacity." If you have a cast-iron gut, aren’t bothered by wild swings in the value of your investments, and the thrill of investment home runs greatly exceeds the pain you feel from the inevitable losses — you have a high "risk tolerance." However, if your savings are modest, your fixed obligations (mortgages, etc.) are large, your income is uncertain or your family needs are high — you have a low "risk capacity," and cannot afford to subject your investments to as much risk

The next thing to think about is time. If you drive from Raleigh to Greensboro and have allotted two hours to complete the trip you will be able to drive within the speed limit and still arrive comfortably within your budget. On the other hand, if you only have 45 minutes, you will most likely have to speed, which increases the likelihood of either getting a ticket or having an accident and not arriving at all. When constructing a portfolio, the earlier you start the less risk you need to take in order to achieve your goal — whether that goal is retirement or funding a child’s college costs.

With that background, we’ll now look at three different investment approaches.

Conservative
This approach might fit someone with low risk tolerance and low risk capacity. Here’s an example of a conservative asset allocation:

• 25%-50% in Savings Accounts, Money Market Funds and/or CDs
• 25%-50% in Government or High-Quality Corporate Bonds
• 15%-25% in Dividend-Yielding Stocks

When I refer to bonds or stocks, this could be accomplished using individual securities or through mutual funds. The conservative allocation has most of the assets in "loaner" investments, but does recognize the need for some more growth-oriented investments. The stocks (or funds) that are used are the more conservative dividend-yielding stocks.

Moderate
A moderate approach resembles the traditional “balanced” allocation and looks something like this:

• 10%-20% in Savings Accounts, Money Market Funds and/or CDs
• 30%-40% in Government or High-Quality Corporate Bonds
• 40%-60% in Stocks (various types)

The moderate approach seeks to balance the allocation between “loaner” and “owner” investments. Also, the stocks would not be limited to just dividend stocks, but would also include more growth-oriented stocks (or funds) that don’t pay dividends, as well as an allocation to smaller companies and international markets.

Aggressive
Finally, let’s look at a more aggressive approach. It might fit someone with a higher risk tolerance, higher risk capacity and a longer time horizon.

• 0%-10% in Savings Accounts, Money Market Funds or CDs
• 10%-20% in Bonds (various types)
• 70%-90% in Stocks (various types)

Obviously, the aggressive approach is predominantly in stocks. In addition to the types of stocks used in the moderate allocation, you might now add some exposure to stocks (funds) in emerging foreign markets as well as increasing the allocation to smaller companies or other more specialized areas. In addition, the bond allocation might move beyond just high-quality bonds and nibble somewhat in higher-yielding, but lower-quality, bonds.

These sample allocations should get you started on developing your own personal allocations. There’s nothing magical about them and you should view them as guidelines, not straight-jackets, since everyone’s situation is unique. On the other hand, if your allocation is wildly different from the above, you might want to use these as a reality check.

Gerald A. Townsend, CPA/PFS, CFP^®, CFA^® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com