Tuesday, March 31, 2009

balanced vs. balanced portfolios

diversification has been spouted as the key to earning money in the stock market.
common sense, and age-old cliche's of putting our eggs in a basket on the way to grandma's house aside, there is considerable evidence that investing across the broad spectrum of the economy, domestically and internationally is a highly reliable strategy in terms of overall captial preservation. I agree with the simple logic of investing in something (eg. a sector of the economy) that makes money when another investment(eg. in a negatively correllated sector) is losing money- a straightforward way to understand and manage economic cycles and volatility.

This is only half the story. the other half is the extra homework that the individual investor must do in order to understands how this concept of diversification applies to their specific context. Are you a young millionaire, who inherits a large steel conglomorate? are you a middle-aged construction site manager with a union-backed pension, 3 kids, and a mortgage on a house that just lost 7% of it's estimated valu? a young or old teacher? a lawyer with the government or a private firm?
all of these people have dramatically different investment needs that can be optimized not only for their earnings potential, but their overall sense of security in their investment. This security is not only psychological, but translates into garaunteed interest payments and return of capital. Diversification, with respect to preserving captial and providing opportunity for earnings growth, -for all of these different people- means different things.

it's difficult to create a portfolio for a sample, or imaginary person, because everyone in real life is so different, so here is what you should do if, at any age, you recieve a one-time windfall of $400000. maybe you had to payoff a mortgage and for kids to go to school and this is the life savings you are left with after you sell your house and move into a smaller place. maybe you are borrowing money on margin to invest. here's two ways to invest it and you can gauge the relative risks and rewards for yourself.
the first is a typical 'balanced portfolio' for someone with a long-term time horizon (10-15 years), which for some of these advisors is an eternity, and the other is for a 'balanced' bond portfolio. both would either allow you to reinvest the yield for the sake of compounding or could be counted as income.
both will be based on current price and yield quotes.

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