Risk comes in various forms, but the average investor’s primary concerns are “credit” and “market” risk … particularly when it comes to investing for income. Credit risk involves the ability of corporations, government entities, and even individuals, to make good on their financial commitments; market risk refers to the certainty that there will be changes in the Market Value of the selected securities. We can minimize the former by selecting only high quality (investment grade) securities and the latter by diversifying properly, understanding that Market Value changes are normal, and by having a plan of action for dealing with such fluctuations.
You don’t have to be a professional Investment Manager to professionally manage your investment portfolio, but you do need to have a long term plan and know something about Asset Allocation … a portfolio organization tool that is often misunderstood and almost always improperly used within the financial community. The K. I. S. S. Principle needs to be at the foundation of your Investment Plan; an emphasis on Working Capital will help you Organize, and Control your investment portfolio.
If you don’t allow the “engineer” gene to take control, this can be a fairly simple process. Even if you are young, you need to stop smoking heavily and to develop a growing stream of income … if you keep the income growing, the Market Value growth (that you are expected to worship) will take care of itself. Remember, higher Market Value may increase hat size, but it doesn’t pay the bills.
Deduct any guaranteed pension income from your retirement income goal to estimate the amount needed just from the investment portfolio. Next, determine the total Market Value of your investment portfolios, including company plans, IRAs, H-Bonds … everything, except the house, boat, jewelry, etc. Liquid personal and retirement plan assets only.
Organizing the Portfolio involves deciding upon an appropriate Asset Allocation … and that requires some discussion. Asset Allocation divides the investment portfolio into the two basic classes of investment securities: Stocks/Equities and Bonds/Income Securities. A second misconception describes Asset Allocation as a sophisticated technique used to soften the bottom line impact of movements in stock and bond prices, and/or a process that automatically (and foolishly) moves investment dollars from a weakening asset classification to a stronger one … a subtle “market timing” device.
The Asset Allocation Formula is often misused in an effort to superimpose a valid investment planning tool on speculative strategies that have no real merits of their own, for example: annual portfolio repositioning, market timing adjustments, and Mutual Fund shifting. The Asset Allocation formula itself is sacred, and if constructed properly, should never be altered due to conditions in either Equity or Fixed Income markets. Changes in the personal situation, goals, and objectives of the investor are the only issues that can be allowed into the Asset Allocation decision-making process.
(2) Any investment portfolio with a Cost Basis of $100,000 or more should have a minimum of 30% invested in Income Securities, either taxable or tax free, depending on the nature of the portfolio. Under age 30, it is a mistake to have too much of your portfolio in Income Securities. (4) From Retirement Age– 5 on, the Income Allocation needs to be adjusted upward until the “reasonable interest rate test” says that you are on target or at least in range.
Limit Equity involvement to Investment Grade, NYSE, dividend paying, profitable, and widely held companies. Don’t buy any stock unless it is down at least 20% from its 52 week high, and limit individual equity holdings to less than 5% of the total portfolio. With a 40% Income Allocation, 40% of dividends and profits would be allocated to Income Securities.
For Fixed Income, focus on Investment Grade securities, with above average but not “highest in class” yields. With Variable Income securities, avoid purchase near 52-week highs, and keep individual holdings well below 5%. Take a reasonable profit (more than one years’ income for starters) as soon as possible.
Monitoring Investment Performance the Wall Street way is problematic and inappropriate for goal-orientated investors. Greed, then fear, new products replacing old, and always the promise of something better when, in fact, the boring and old fashioned basic investment principles still get the job done. Remember, your unhappiness is Wall Street’s most coveted asset.
No matter how you slice it, your long-range comfort demands regularly increasing income, and by using your total portfolio cost basis as the benchmark, it’s easy to determine where to invest your accumulating cash. Since a portion of every dollar added to the portfolio is reallocated to income production, you are assured of increasing the total annually.
To realize a profit, you must be able to sell the securities that most investment strategists (and accountants) want you to marry up with! When you can get yourself to the point where you think of the securities you own as high quality inventory on the shelves of your personal portfolio boutique, you have arrived. Reduce the markup on slower movers, and sell damaged goods you’ve held too long at a loss if you have to, and, in the thick of it all, try to anticipate what your standard, Wall Street Account Statement is going to show you … a portfolio of equity securities that have not yet achieved their profit goals and are probably.
Working Capital Growth (total portfolio cost basis) just happens, and at a rate that will be somewhere between the average return on the Income Securities in the portfolio and the total realized gain on the Equity portion of the portfolio. It will actually be higher with larger Equity allocations because frequent trading produces a higher rate of return than the more secure positions in the Income allocation.
Is there really such a thing as an Income Portfolio that needs to be managed? By using Cost Basis (Working Capital) as the number that needs growing, by accepting trading as an acceptable, even conservative, approach to portfolio management, and by focusing on growing income instead of ego, this whole retirement investing thing becomes significantly less scary.
