What should your stock portfolio look like?
Tess Vigeland: Some time ago I asked our fans on Facebook what kinds of financial questions they’d like answered on the show. We’re going to address one of those today. It’s a phrase we use quite a lot and we assume everybody knows what we’re talking about. That’s not a fair assumption. So today we’ve asked Stuart Ritter back. He’s a financial planner at T. Rowe Price. And Stuart we’d like you to explain asset allocation. Go!
Stuart Ritter: Well, you know us financial planners, we like to give fancy terms to basic concepts. Asset allocation simply is referring to how much of your money you have in stocks, how much you have in bonds and how much you have in short-term investments. How you’ve allocated your money across those three different assets, hence asset allocation.
Vigeland: We will often get questions asking whether there’s a difference in allocating, for example, over providers. So, is it OK to have all my money in T. Rowe Price? Or should I…
Ritter: Of course!
Vigeland: Of course, yeah. Or should some of it be in T. Rowe or should some of it be in Fidelity and some of it in Vanguard? But that’s not what we’re talking about. We’re talking about where your money is sitting in various investments.
Ritter: Right. It’s getting the right balance in your portfolio between the two things everybody wants. Short-term stability and long-term potential growth. And the reality is the more you have of one, the less you have one of the other. The more money you have in stocks, the more potential growth you have. But the more short-term volatility you’re going to experience. So the way you decide how much to have is based on your goal’s time horizon. If you’re not using the money for a very long time, the biggest threat to you being able to buy what you want to buy, is not what the stock market does in the next three weeks. It’s how much inflation is going to increase the price of college tuition or accrues when you retire. The flip side is, if you’re using the money in the next two years, you don’t want anything in stocks. You don’t need the growth, you don’t want to take on the risk of the short-term volatility, so that’s how you decide how to allocate across stocks, bonds and short-term investments.
Vigeland: What about allocations within those kinds of big buckets, which you talked about. You have stocks, you have bonds, you have short-term, possibly cash, like a money market account. There are also questions that come up about asset allocation, for example, within stocks.
Ritter: Yes.
Vigeland: So people want to know how much should I be in emerging markets, how much should I own of the S&P500 or a total market fund? How do you determine that then? Is there an appropriate percentage?
Ritter: What you’re getting at is what you call with that fancy word “diversification.”
Vigeland: Yes.
Ritter: If you have all of your money in one stock and something bad happens to that single stock…
Vigeland: Enron?
Ritter: There you go! There are all kinds of examples. Your ability to pay for what you want to pay for if something negative has happened is severely compromised. That’s why we say since you don’t know ahead of time what’s going to happen to an individual stock, own lots of them. In the guideline we give people at T. Rowe Price is about 60 percent of your stock portfolio should be in large U.S. companies, about 20 percent in medium-sized and small U.S. companies and about 20 percent in international companies. So however much you have in stocks and that’s again based on your goal’s time horizon — mix it up between large U.S., medium and small U.S. and international. Same thing on the fixed-income side. You want different kinds of bonds: Investment-grade, high-yield, international. Put those kinds of portfolios together.
Vigeland: Stuart, thanks for coming in.
Ritter: Thanks for having me.
Vigeland: Have you been scratching your head over some financial term you’ve heard? We would love to explain it. Write to us or post on our Facebook page.
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