Basics: Stock Portfolio Allocation

Anyone involved in investing ponders the question “how much should I invest in the stock market?” I have seen stock allocation equations in Kiplinger Finance Magazine and other places range anywhere from “120 – x (your age)” to “100 – x (your age)” to determine what percentage of your investment portfolio should be allocated to stocks. So let’s take my age and use the arbitrary equations:

At the age of 24:
a) 120 – 24 = 96%
b) 100 – 24 = 76%

The difference between 76% and 96% is quite a huge difference and I can say that I am personally more comfortable investing 76% of my portfolio in individual stocks. That means when you get to be 65 years old and at the point of retirement, your stock allocation could be as follows:

At the age of 65:
a) 120 – 65 = 55%
b) 100 – 65 = 35%

I think that when I’m 65, I’m also going to feel more comfortable not having more than half of my portfolio in riskier stock investments and keep it in more conservative plays like mutual funds or certificates of deposits with a stable interest rate. So there really is no “rule of thumb” equation that the average investor can point to and determine how much they should invest in the stock market. What this does say though is that the younger you are, the more comfortable you should be in investing a larger percentage of your portfolio. Whether that number is over 90% or maybe just 50%, it has to be comfortable for you. There are so many other factors that we have to consider before we decide how much to allocate toward stocks; like mortgage payments, car insurance, monthly car payments, wedding costs, money for a rainy day, and forking out $600 for an iPhone. Financial situations vary so much from one person to another.

But my golden rules when investing in the stock market are these and you can choose to follow them or not:

1) Diversify your portfolio no matter what. As witnessed with the dot com bust and the subprime mortgage downfall, you never know what will happen.

2) Only invest in stocks that you understand. Don’t run after a company that your friend told you is hot but you know nothing about their business plan or future growth potential. Many people got burned 6 years ago because they bought anything with a “.com” in the name and they had no clue what the companies did. I bet some people investing in those companies were even unsure how the Internet worked. Like I said in my previous post, don’t run after any company that produces ethanol, but make sure you invest in a company that has a solid business model for the long term and can weather through rough times.

3) Try not to let emotions affect your investment strategy. People will tend to let past bad or good decisions affect how they make future investments and that is not the right way to go. One example is that someone loses money in the oil sector and they’ll be afraid to invest in oil again because of the fear of losing more. Another example is not buying a company that goes up a lot (let’s say Amazon.com as of recently), and the investor gets frustrated that they didn’t buy into it so they chase the stock and buy it at a higher price so they don’t miss the next run up. This has a tendency to bite a lot of people in the behind.

4) If possible, don’t invest more than 15% in any one company. This number changes depending on how much you have to invest and if you want to cost-average a stock if it goes down.

5) Get some stocks that pay dividends into your portfolio. Usually those stocks are less volatile and they give you a steady source of interest income. Usually.

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