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Portfolio Allocation: How to think about your investments


In today’s episode, I’m interviewed by Matt Robison in his on-air radio show Your Money - where we talk about Investing and Portfolio Allocation.  What is a stock or bond?  How should you think about diversifying your portfolio?  And be sure to listen to the end where we discuss how to think about your portfolio and investing future.

Topics Covered

  • What does Portfolio Allocation mean?
  • What is the difference between Stocks and Bonds?
  • How do you choose how much of each to own?
  • What are the returns of stocks versus bonds?
  • Create a plan and stick to it.

Photo by Alex Loup on Unsplash


Matt: [00:00:00] Mike welcome. 

Mike: [00:00:01] Thanks, Matt. Thanks for having me 

Matt: [00:00:02] Very glad to have you back. We thought we were talking about this before we started recording this maybe we should break things down. To the, to sort of the starting point, we wanted to talk today about portfolio allocation. Now these are some big words for, I think, a pretty simple concept.

So let's start off, Mike, what does portfolio allocation even mean? And why is it important to think about for investors? 

Mike: [00:00:30] Yeah, thanks, Matt. I think this is a really, really important topic. And so definitely we're going to dive into a little bit of jargon. We'll try to break it down as we go. Matt we'll keep me honest.

Whenever I'm spitting out some financial terms during this segment we'll make sure we're defining those. So your portfolio allocation, what you think about is when I say the word portfolio, it's all your accounts total together. So you have some savings accounts, checking accounts, maybe brokerage accounts, retirement accounts, right?

You've got five or six different things. If you're married, you double that you got 10 different things. So a portfolio is the entire bucket, all of those put together in one pie chart. All right. So imagine a pie chart of all of those accounts and what you own in each of those accounts, you might have some cash, you might have some stocks, you might have some mutual funds.

You might have some bonds. Okay. So now we can say, we can assign colors to each of these are slices within that total pie of what is in each account. That is your portfolio. And the question is, all right, great. Why is that important? Why should I care? You know, across all these different accounts, my retirement account, I got that dialed in.

You know, why do I have to total all these different accounts? And the reason is that it is the number one driver of your return, what you're invested in across all those different accounts. Is the number one driver of what the return is going to be for your portfolio. And obviously, that's very important to investors.

You want to get a return on your money so that you can do more things in the future. 

Matt: [00:01:56] All right. So let me make sure I'm following this. So your portfolio is the slices of pie in your pie. The allocation, when you say portfolio allocation is how big each of those slices is. And your goal. The name of the game is as George W.

Bush famously once said to make the pie higher, you want to increase the size of the pie and you want to prevent anyone from sneaking up and taking bites out of your pies. Is that close to right? 

Mike: [00:02:23] Yeah, that's right. You definitely the bites out of your pie could be that the taxes. Right. They come into the government coming in and taking bites out of your pie depending on what it's invested in.

But that's exactly right. I want to grow that pie over time and use it for your own goals. And that could be different for everybody. Okay. But the allocation you're exactly right. Is what you're invested in kind of the slices of that pie across those different accounts. So before I start talking about that, let's, let's break it down to some blocking and tackling some.

Yes, please. Basics. All right. So the first thing at the highest level across this pie are stocks and bonds, ? And these are two different, two different things that we can invest our money. We can put our money in and of course there's cash as well. So I should say that stocks, bonds cash might be the three,  biggest components.

So the stocks, when I'm saying stocks or equities, That is investing in a company. That's somebody started a company or it's a public company and you give them a $10,000 and you own a piece of that company. So hopefully the company does well, it gets bigger hires. Employees gets more profits and you own a piece of that.

You get a piece of the profits, you could sell it to someone else down the road, but you own a, a piece of that company. In contrast a bond is an IOU. All right. So I lend money to somebody. I give somebody $10,000. I lend it to you at 2% interest over a year or 10 years, and you're going to pay me back plus that interest.

And I get my money back. All right. So that's the difference between a stock and a bond. Okay. 

Matt: [00:03:48] I see. So with a bond, you're, you're handing out some money, you buy a bond. So, you know, you, ,  pay 30 bucks today, but in X number of years, you're going to get 15, the bucks back 

Mike: [00:03:59] that's right. Yeah, exactly. 

Matt: [00:04:01] Got it.

All right. So, okay. , I think I get , the difference there. So What should I invest in? 

Mike: [00:04:07] How does one decide? So where did we go? Yeah, there's a couple of, well different levels we going to get to, but how do we decide? You know? Okay, great. I can, I can put my $5,000 into, into a stock. I can put my $5,000 into a bond, you know?

W what should I choose? Well, the nice thing is you don't have to do all of one or the other, right? You don't, you know, you could split it up. It's a very easy to split these things up. Now you could do a little bit here a little bit there, so you don't have to go all in on one side or the other. And then of course, the nice thing.

Is that these are what are called non-correlated assets, ? Stocks, bonds, and cash. When one is going up the stock, market's doing well. , even given all the turmoil of last year, the stock market actually went up pretty significantly. When that happens, maybe bonds don't go up as much. And the other way it could be true to stock market tanks.

You know, we had the big dip last March and stocks really took a hit bonds. Didn't really move that much. And so that's why , you do want to own some of both because they move different directions at different rates. 

Matt: [00:05:05] So, I mean, would it be okay for me to just say great, grab some of column a, grabbed some of column B I'm good to go.

Some stocks and bonds. Pretty much it, 

Mike: [00:05:16] Well, that's a good starting point is you definitely want to think about having some of both and it really depends. And we'll talk about this depends on where you are in the life cycle of your career and your family and other questions like that. But once we've gotten stocks and bonds within each of those.

It gets more complicated. There are subclasses. All right. And so within stocks you could invest in large companies or small companies, you could invest in us companies or international companies. . Within bonds, you can invest in the government, us government, European government issued bonds to, to fund their projects.

Or you can invest in companies, bonds companies need to raise money. They don't, Often issue bonds. And so you can say, Oh great. I'll, I'll lend Amazon 10,000 bucks and they'll pay me back, you know 13,000 bucks in a couple of years. So you have corporate bonds as well as us government bonds or other government bonds.

So in each of these, there are sub asset classes. Okay. And again, we want to roll those up to the big pie. Picture, but , once you get to the stocks and bonds, it might be 50 50, just for argument's sake. Then within each of those, you might also have some subclasses. 

Matt: [00:06:24] I see. So  do you want to spread out among different types of classes?

, do you want to concentrate in one area? 

 Mike: [00:06:33] . So there's different approaches to investing. Some people do like to concentrate in one area. They think they have some insight into, , this area might do really well in the next year or two. And so I'm going to put more of my money into the us stock market or when we think socks are overpriced, let me, you know, get out of that a little bit more into bonds so you can concentrate.

However, I would say in general, you want to really diversify across all of these asset classes own a little bit of everything, because that is the only free lunch is the diversification, right? When we're invested all in one thing like Enron stock, that could go to zero, you know? And so you want to be very careful when you're getting highly concentrated into a particular area.

So in general, we want to spread everything out and get that diversification. 

Matt: [00:07:17] I see. So the more concentrated you are in some ways, the more risk you're taking on the more diversified you are in some ways you're spreading. Let me try it. Let me try another metaphor on you. We've tried pies. Let's try horse racing.

It sounds like part of what you're saying is that your investing is a little bit like betting on a horse race. And when you diversify, you get to put your money on more than one horse at a time, the more horses you've got some money on the better chance that one of them is going to come in.

Mike: [00:07:45] Yeah. That's exactly right.

And in fact, when you look at the returns, we haven't talked about it too much yet, but the returns of these different asset classes, as mentioned earlier, do different things. Sometimes stocks go up and bonds stay flat. Sometimes stocks go down and sometimes the us does really well. Sometimes international does really well.

So across all these different classes, you don't know which horse. You know, is going to win. So by spreading the doubt, you always have some disappointment, Oh geez. These ones didn't come in at all. But you always have good gains. And so , you're spreading out your risk and you're getting sort of diversified reward.

Matt: [00:08:17] And you're ending up ahead of the game in the long run. So how do you make those decisions? How do you, how do you choose which horses , you're going to put more on, less on skip altogether, 

Mike: [00:08:28] right? Exactly. So , nowadays it's pretty easy, which is great because we have mutual funds and exchange traded funds where you can invest in the entire us stock market with just a hundred bucks and get,  , thousands of companies.

And so the financial industry has really changed over the last couple of decades, such that it's easy and cheap to invest in these things and get the diversification. So you can start really simply and look at that entire portfolio and say, I'll invest in the us stock market. The international stock market and the global bond market.

And when I say global bond markets, you know, all bonds across kind of us and international. So you could literally have three investments within your portfolio, your retirement accounts, your brokerage accounts, and just keep it very simple and just have those three. And that's a great starting point. 

Matt: [00:09:14] In some ways, it sounds to me and my much less educated ears.

Like you're making it seem like the job of investing has gotten a little bit easier as these kinds of new products have been offered by financial services companies. But in a way, it also sounds like. These are some incredibly complicated things. They can have many different pieces inside them. There are many different products offered by different financial institutions.

And as you said before, they can have different mixes of international us stocks, bonds commodity. We haven't even gotten into that. So is that where you come in in helping clients and working with people to make those kinds of decisions? 

Mike: [00:09:56] Yeah, absolutely. So that's one of the things that is a challenge.

You could think you're diversified. Hey, my retirement account, I picked these three different funds and I'm in this and my wife's retirement account. She's got these three different funds. We're diversified, we're going to six, eight different things, but it could turn out those things, all own the U S large market, us large companies.

And so you're just invested in one asset class, even though you own six to eight,  , different funds. And so you really need to. , pull it up to that big pie chart back to the pie analogy and see , what you hold. And there are different technologies out there that do that from different software packages that you can find online for a consumer financial advisors.

Of course, do this all the time, pull together multiple accounts and take a look at it from the high level so we can understand, Hey, where are you more concentrated than you might want to be? 

Matt: [00:10:47] And of course, one of the other complications that I've noticed in my own life is that with all of these choices that are out there and you know, you and I had a professor for our listeners, Mike and I went to the same college, we have the same Alma mater and there is a, there's a famous professor there who teaches about the psychology of choice.

And he's found that the best number of choices out there is like six to 10, any more than that. And it actually gets confusing and demoralizing. So if you go to the grocery store and you see 57 different kinds of ketchup, you're pretty bummed out. And that's sometimes the way I feel when it comes to investment choices.

It's not just that there are so many choices, which is a bummer in itself. It's also that so many of them. Look so similar, but really when you get down into the nitty gritty details, they are not, I I've discovered that I had a, it was a different type of account. I had an account for trying to save for college for my kids.

And   , it was incorporated in South Dakota for some reason. And I, I wasn't sure I understood all of the details that went with that. So, I mean, is that also one of the things that people need to watch out for is that there are some fine grain details. That make differences between things that on the surface look pretty similar as like, Oh, you can, you can get a big bundle of stocks with this type of thing.

You can get a big bundle of bonds with this type of thing. Are they, are they deceptively different down below the surface? 

Mike: [00:12:13] Well, unfortunately they are, but at some level, does it matter to you as an investor? Some things do and some things don't. So let's take sticking on the portfolio allocation.

 I'll pick another product called a target date fund. And so a lot of listeners will have this in the mix and their retirement accounts, target date funds. You could put all your money just straight into a target date fund, and it will automatically do the allocation for you based on the year of retirement.

So you may have seen these, you know, target date fund 2055 and you put in your 10,000 bucks there and it's got some stocks. It's got bonds, us international. Does all that for you. Yeah, I've got one of 

Matt: [00:12:48] those. I love it. I don't want to do anything else cause it does anything for 

Mike: [00:12:51] me. That's great. It's a word.

Isn't it. It's a great, it is a great product. I really like target date funds. There are some downsides, but for people that are just  , accumulating money, kind of mid-career, you know, early career, mid career. They're great. You can put your money in there month in and month out and not worry about it too much.

But, but to answer your question. So if you've got one of these from one company versus another, you know, different companies have them, Schwab, fidelity, Vanguard, all have these kinds of target date funds. When you look under the hood, they are different. They could be off by 10 to 20%    how to spread out that money, how to diversify it.

And  doesn't matter to you as a consumer. Not really , they're all gonna do pretty well. I mean, I can tell you a year later, which one did better? But going, you know, going into the year, I can't tell you which one is going to do better and they're all designed to do you know, what they're supposed to kind of lead you towards retirement.

So there's a single Fonda target date fund that does the diversification for you. And I'm a big fan of those products. 

Matt: [00:13:45] So speaking of how things might do a little bit better might not do as well. So I get, obviously the things move up and down at different rates at different times.  If I am looking to kind of construct a portfolio myself, How should I think about return for each type of asset class , or for the portfolio as a whole?

What should I be looking for?

Mike: [00:14:11] Yeah. Again, back to the, the starting point stocks versus bonds. Historically, we can look backwards and say, what have investments in companies done, you know, owning a piece of that company. And historically they do about 10 to 11% per year on average. Now, I'll tell you a story about averages in a sec, but tend to tend to 11% per year on average.

Whereas bonds do about five to 6% per year. Now those are nominal returns. They're not included of inflation. All right. And right now we're in super low inflation. So no one's really thinking about it, but historically it's been almost 4%. So you've got to take, you know, your buying power is going down by 4% a year, even if you're making 10 or 11%.

So you got to take that off the top, you know, for how much purchasing power you're going to have in 10 or 20 years,  on inflation. But remember these are averages and the stock market rarely hits it's average less than 10% of the time will it actually hit that within a year? Last year, the S and P 500 was up 18 to 20%.

All right. Well, above,  , that 10% average. 

Matt: [00:15:09] Okay. So I have to call time out here and in with the suspicion of shenanigans, but you can set me straight. Now. I majored in economics in college. I didn't pursue a PhD because it turns out I'm not super great at math, but. I can tell the difference between you said stocks about 10 to 11% return bonds, five to 6%.

Sounds to me like stocks, you would expect about double the return from bonds. So why do bonds at all?

Mike: [00:15:40] Exactly. That's a great question. Well, the reason is because in any Longer period of time again, we're talking averages, right? So I agree with you. If you've got a hundred years great, all in on the stocks.

Cause that's what we're looking at in terms of history in the averages is about a hundred years. But when you look at any 10 year period or even 20 year period, okay, we could be well away from those averages. I was just looking at a chart last night of the S and P 500 for 10 years.   Through the nineties, it was basically 17% a year, 17% a year compounded for 10 years.

Well, then 2000 happened 2000 to 2008, minus 3% a year. Wow. Minus 3% a year for eight years. That was the average annualized return for stocks. So that's why we own bonds. There's a couple of reasons to own bonds. That's one of them obviously is, is the volatility. If you need cash soon, that's a reason to own cash or bonds I'm talking to in the next year or two.

Obviously, you're not going to put that in stocks that can go down to 50% in a year. All right. So if you need that money, that's a reason for owning cash or bonds. And then, like I just said, even within a decade,   who knows where these things are going. So you gotta be careful and make sure you have some allocated towards that bond side of things.

Matt: [00:16:50] So it sounds like, especially if I'm getting a little bit closer to retirement, which,  , let's face it with my podcasting and radio career, it's probably pretty far off. That's the kind of situation where maybe I'd want. A bit more in bonds, a bit less than stocks so that I don't face that kind of volatility as I approach the time that I'm going to want access to the cash.

Mike: [00:17:11] Yeah, that's exactly right. So at the high level we could say, Hey, I want to be 80% stocks or 20% bonds, or I want to be 50, 50, but another great way of looking at this is when you need those dollars. So if I have $5 today, then I'm going to spend next year cash the next 10 years. Maybe bonds. Okay. Cause , they tend to,  , not be nearly as volatile if it's 20 or, you know, 10 plus years that I need that five bucks stocks.

And so that's why when you're young, if you're in your twenties and thirties, you can be 80, 90, a hundred percent stocks because that $5 you're putting away today, you will not be using for 20 years. If it's saying,  , definitely in your retirement account, but as you're, you know, within five or even 10 years of retirement, That's where we often transition and say, wow, I need to be holding some more bonds because I can't have this portfolio that I'm relying on,  , go down by 30 or 40%.

Matt: [00:18:02] One thing that I haven't heard in your explanation so far is a focus on sort of the week to week, day to day of how the stock market is doing, which,  ,   as a popular consumer of information, one hears a lot about that. You know, what's up, what's down, you watch Jim Kramer on CNBC and  , it's all about like what's hot today.

Does that have anything to do with it? Or are you really talking about a strategic approach over the long-term 

Mike: [00:18:32] I guess almost completely ignore the noise of market commentary from day-to-day and week-to-week of course it's things can move very quickly. Yeah, we've seen that recently. So we have some good firsthand knowledge of watching that.

And it's exciting to listen to the news, read the news every day, see what's going on in the market that this and that realize all those headlines are looking backwards. And so when you're reading news stories, Oh, the market went up by 1% because well, whatever comes after that, because they're making up.

Because that's what happened yesterday. So that's the re that must be the reason we're in reality. You never really know what's moving things day to day, even year to year. To be honest, you really don't know  what's driving that and it can be, well, let's just look at last year for a great example.

What is driving a market going up 20% during a year of crazy pandemic. But when you start looking at five, 10 and 20 years, that's where the. The turns of these things average out over time. Oh, good companies still making strong profits. Yes. They go up and up and up. Right. Because they're performing. And, and the same on the bond side, you know, you stay pretty steady based on interest rates.

So that's why looking for the long-term. This is exactly that I would always view your portfolio as a long-term investment towards the goals that you want, whether they're one year, five years or 20 years away.

Matt: [00:19:48] Sounds like the weather report. The weather person is very good at saying, well, here's what happened yesterday.

And here's why, but can't tell you a lot about what the weather is going to be like next month. All right. I'm going to leave the, the last word on this to you. Any final thoughts? Anything else that listeners should really know about? 

Mike: [00:20:04] , I think just what we were just talking about is really, really important.

Have a plan and stick with it year in and year out when the market tanks  , don't get scared. If those dollars were for 10 years from now, it really doesn't matter. It's not going to make a difference. Stick with your plan. Have a good allocation between stocks and bonds that you can review once a year and then keep with it.

Matt: [00:20:26] Well wise final words on that. Mike Morton of Morton Financial Advice. Thank you very much for giving us this really fascinating. Run-through of just the basics and boy, it sounds like there's a lot more we could discuss on all of these points that you raised and we'll look forward to continuing to do that.