Tuesday, February 26, 2008

Does your Discretionary Portfolio have Too Much Risk? Consider Alternatives

If you have established your Discretionary Portfolio (money not for retirement and money you can afford to lose), congratulations. You may have heard that over the long term, stocks and stock funds can return around 10% annually with risk and volatility.

According to research from Charles Schwab, the longer you hold stocks (based on the S&P 500 returns 1926 to 2005), the lower the volatility of your portfolio performance.

However, are you taking much risk in your (Taxable) Discretionary Portfolio?

  1. Have you established an emergency 3 to 6 month fund in safe money market funds? If you haven't, consider selling some assets in your Discretionary Portfolio to build up your 3 to 6 month emergency fund.
  2. Do you have high rate consumer debt such as car loans or credit cards? If you have credit card debt at a rate of 12%, for example, move money from your discretionary portfolio to pay off your consumer debt. In the recent example, by paying off your consumer debt, you'd be making 12% return risk-free!
  3. Do you need the money for a large purchase (for example, down payment on a home or tuition for your children) within five years? Consider moving the money to more conservative investments. Based on Schwab's Research above, are you willing to lose 12% to 27% per year before you cash out your discretionary portfolio? If you can't afford that volatility, consider moving money from your discretionary portfolio to safer investments such as money market funds and high yielding online savings accounts.
  4. Many people are speculating when the housing crisis will be over. If you do not own a home, and you think the housing bottom may be here within three to five years, then consider moving money from your discretionary portfolio to safer investments to protect your down payment.
  5. Are you sufficiently diversified?

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