The market is on track to close below 8,000 again (say, didn't the Senate approve the stimulus plan today as well?), so it is time to pity the sellers in a buyer's market! Luckily, I have all my bills paid and enough cushion to raise my 401 contributions comfortably. But it's not money that I plan to let go to waste in the market. Today, I am going to reallocate my 401(k) investments and I expect to do this periodically. The strategy of "buy & hold" might be outdated and ineffective, but at the same time, if you're only 30 years old, what choice do you have? Timing the market like a ridiculous casino game is unwise, so the key is to start from the top-down.
Establish goals, wants, and needs, and then from there, create an asset allocation as your guide. The difference between 20% and 30% return in one given year is far less meaningful than the average return of 2% to 8% (bonds) to 11% (stocks) over the course of 10 years or more.
Once you have spent enough time with that figure, then you have your go-home number which your overall mix should reflect at all times. For example, let's say your target as an investor aged 25-35 is 90:10 stocks-to-bonds, then 90% of your existing money should be in stocks and 10% should be in bonds. As you get older, you would want to shift your bonds to a higher percentage, and as you near retirement, you will want to introduce stable value options (money markets) into the mix.
If you're under 25, then why not have all your money in the stock market? Because if you started investing at age 25 and you're now 27, and the market took its hit, the Vanguard Total Stock Market fund is posting a 3-year return of -8.45%. Meanwhile, the Vanguard Total Bond Market fund is posting 5.41% for the same period. So, if you had balanced (even an insignificant amount like 90:10), then your return would be far greater, maybe -3.77% -- which happens to be the 3-year return of the Vanguard STAR Fund (by far, my favorite investment).
To revisit the question, why not have all your money in the stock market if you're under 25? Hedging! Experts will differ on this issue, but in my opinion, if buy & hold is outdated, then allocation mixes are the only way to go. If your stock portion is greatly outperforming bonds, then your target mix will be off. Let's say you want 90:10, but it's currently at 92:8, simply move 2% from stocks to bonds. That's called "rebalancing," but in this case, we know that the only way the mix will get skewed is if stocks or bonds are over-performing or under-performing, so you invest in those that are under-performing while they're under-performing and you drop those that are over-performing while they're over-performing. In practice, that's enabling you to "buy low, sell high" without having to don a genie hat (or worse, to chase returns).
Myself, I am introducing a new fund into my portfolio today: the aforementioned Vanguard Total Bond Market fund. As such, I am going to put a larger than desired portion of my incoming contributions to this new fund. In average market conditions, I would consider putting 100% to the new fund to build it up (until it is at least 10% of my mix) but I don't want to miss on any market recovery in the next three months either, so I am going to split my incoming investments evenly between this new fund and the Vanguard Total Stock Market fund.
About three months from now, I will revisit my incoming contributions and redirect the incoming money to play a direct role in my asset allocations.
DISCLAIMER: Although many of you know that I work in finance, please be aware that I am neither licensed nor permitted to give advice and if you want to get specific recommendations, then you should consult with a financial advisor or reputable financial sources, my favorite website is CNNFN.com and my favorite radio station is KFNN 1510 AM. Many financial plans are at no cost to you (because the advisers are paid by the investments where your money is placed).
