Being a faithful steward with your investments
Ecclesiastes 11:1, 2 “Cast your bread upon the waters, for after many days you will find it again. Give portions to seven, yes to eight, for you do not know what disaster may come upon the land.”
Many investors try to “time the market”—that is, they buy when they believe that the market is headed higher and then sell when they believe that the market is going lower. God’s Word says (and history shows) that no human can consistently predict the future value of any market or stock (Proverbs 27:1). Hence, there is a need for biblical diversification in one’s portfolio.
Since only God knows the future (Isaiah 46: 9, 10), then the only possible way to be able to “time the market” with any consistency is in total dependence upon God for his specific direction (see John 15:5, Psalm 32:8). Over the years, I have seen a few situations where God has revealed the direction of markets to his children.
If you’re someone who invests in your 401(k), 403(b), 457, Traditional IRA, Roth IRA, Simple IRA, SEP IRA, Profit-sharing plan, single account, joint-account, anywhere, then there’s a bit of wisdom I need to pass along to you. And the timing couldn’t be better either, as we’re invested in time shortly after the 2nd worst recessionary period in history, after the most “fruitless” decade in history for portfolio returns, and we’re getting ready to mark the one year anniversary this week since the market began its now 61% ascension.
I get a kick out of all the “Diversification is dead!” rants we hear nowadays from the media. For as long as we can all remember, we’ve heard the sage advice from people-who-should-know: “Don’t keep all your eggs in one basket!”
How important is asset allocation?
The greatest investor of our time, Warren Buffett, has his own opinions of the importance of diversification for the average investor. Investment pros will tell you:
One of the single most important investment decisions you’ll ever make is how you divide your dollars among different asset types. Why is this process, called asset allocation, so critical? How does it work? And, most important, how can you take advantage of it to help meet your own life and investment goals?
With folks like Jim Cramer and Suze Orman spouting off 24/7 on your cable channel, it’s easy to understand why you and I would abandon the only time-tested strategy that history has taught us for achieving consistent investment returns over the long term. However, a landmark study, “Determinants of Portfolio Performance,” by Brinson, Hood and Beebower, presented in Financial Analysts Journal (May – June, 1992) and its update in 1996, showed that asset allocation decisions, far more than any other factor, affected the long-term performance of an investment portfolio. Asset allocation decisions account for 91.5% of a portfolio’s performance. Individual investment selection accounts for only 4.6%, while other factors – market timing included – accounted for a mere 3.9% of portfolio performance. What does that mean? Even if you could “time the market,” it wouldn’t matter. Even if you were able to pick the perfect stock, it wouldn’t be relevant for the performance of your investments over the long haul.
Why asset allocation still matters
If you’re looking for the “numbers” reason why allocating your assets makes sense, I’d refer you to this article by Henry Kaelber–he does it more justice there than I could have hoped to write. The short version of the long story is that reducing volatility in your portfolio will enhance the returns.
Does Asset Allocation Really Work?
| Strategy | Average Annual Return |
|---|---|
| Source: S&P Micropal, 12/31/08. For illustrative purposes only. The returns shown reflect past results and do not predict or represent future performance. Asset classes are represented by the following indexes: Large-cap stocks, S&P 500 Index; Large-cap growth stocks, S&P 500/Barra Growth Index; large-cap value stocks, S&P 500/Barra Value Index; small-cap stocks, Russell 2000® Index; small-cap growth stocks, Russell 2000® Growth Index; small-cap value stocks, Russell 2000® Value Index; foreign stocks, MSCI EAFE Index; bonds, Barclays Capital U.S. Aggregate Index. Indexes are unmanaged, and you can’t invest in them directly. This illustration assumes that these indexes are reasonable representations of asset classes and their returns. However, investment manager performance relative to the different asset class indexes has varied widely during the past 20 years. | |
| Chasing the winners Investing in previous year’s best-performing asset class |
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| Chasing the losers Investing in previous year’s worst-performing asset class |
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| Allocating among asset classes Investing evenly across asset classes |
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Where can you get guidance?
You’ll remember that yours truly works in the finance industry, specifically in training new financial advisors. So to be fair, I believe in the value of professional advice and think that everyone can benefit from allowing an advisor to assist you with creating a customized plan for how and where your money should be invested. That being said, I understand finding an advisor you trust can be a time-consuming task. If you’re just looking for a better general understanding of how your money should be invested, here’s a few online tools that can get you pointed in the right direction:
- CNN Money’s asset allocation calculator
- Iowa Public Employee Retirement System has a great calculator
- Financial Engines is a more sophisticated calculator that takes into account your existing portfolio and other personal factors and will recommend allocation changes based on your targeted retirement income. Some retirement plan providers offer this service for free. Individual investors may have to pay.
- The Forbes Asset Allocation Calculator is very basic, limiting you to three asset categories: stocks, bonds, and cash.
- The Nationwide Financial Asset Allocation calculator is simple in the inputs it requires: years to retirement and years of withdrawals.
- TIAA-CREF takes a slightly different approach to determining a preferred asset allocation model for you. It presents the reader with different sample portfolios and then asks the reader a number of questions about them.
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