Portfolio Tune-Up Time?
Tuesday, August 7, 2007 | Jason JovineRating:
OK, folks, the market has been ugly lately. I mean that it has been extremely volatile as of late. The CBOE Volatility Index, or VIX, has been approaching its 52-week high. This index is often referred to as the "investor fear gauge." This index is a weighted blend of prices for a range of options on the S&P 500 index. On the economic front, the unemployment rate crept up to 4.6% last week from 4.5% in the prior period. Only 92,000 jobs were added in July, when the street expected there to be 135,000 jobs added.
Remember, folks, that consumers make up about 2/3 of our economy. If there are fewer people working, then there will be fewer people spending and saving, and that is not good for business.
This will affect corporate earnings and hence stock prices, as well. Remember, the market is an anticipatory vehicle, and it will value stocks based on future earnings expectations.
On the positive side of this news, a 4.6% unemployment rate is still very low by historical standards. The higher unemployment rate "should" help the inflation situation out a bit, and if the economy slows down enough, we could see a rate cut by the Fed sooner rather than later.
When the unemployment rate is very low, the supply for workers is low, and the demand is high. This creates what they call a "tight labor market." When this happens, corporations have to pay higher salaries to attract labor and even steal it away from one another. These higher salaries are, of course, inflationary.
Also, there is a rule in economics called the "law of diminishing marginal returns" which basically means that as the number of employees increases, the marginal product of an additional employee will, at some point, be less than the marginal product of the previous employee. In other words, they pay more to the last employees hired than they are really worth. This is inflationary. Get it?
Of course, oil prices are still high and the subprime-mortgage meltdown is in full effect. There was an event that happened in the 17th century in the Netherlands called "tulip mania" in which people were paying ridiculous sums of money for tulips! This was much worse than the dot com bubble and crash of the 1990s because people were bidding up tulips. Flowers, I would say, are about the worst investment that you can make. Other than for peace of mind around the house, that is.
To see another bubble with real estate that is slowly bursting right before my eyes is sickening. Then again, you could fool some of the people all of the time and all of the people some of the time. It is sad to know that there are such foolish people out there as well as those unscrupulous mortgage brokers that preyed on them.
This mortgage meltdown has made banks and other lenders more gun-shy about lending. There is a credit crunch going on. These stupid lenders should have correctly assessed the risk in the first place, and this credit crunch today wouldn't be so egregious. Unfortunately, short-term thinking runs deep on Wall Street.
Back to Business ...
Have you looked at your portfolio lately? If not, I think it's about time that you do. As I mentioned to you a while back, there are many different asset classes. The main ones are:
1. Money market assets (cash equivalents)
2. Fixed-income securities (primarily bonds)
3. Stocks
4. Non-U.S. stocks and bonds
5. Real Estate
6. Precious metals and other commodities
Your portfolio should have a bit of ALL of these asset classes, not just stocks and their derivatives (e.g. options). The amount of each class that you should have depends on your own unique financial (not to mention your psychological) makeup. I will let your shrink talk to you about the non-financial part.
If you are an older person, you probably want to be more heavily invested in fixed income. You cannot take as much risk anymore, since most of your work years may be behind you, and it may be difficult to recover from financial loss. If you are younger, then the opposite would be true.
When I titled this article "Portfolio tune-up" I wanted you all to look at your portfolio the same way you do yourself or your car. Every so often, you need to give your portfolio a "tune-up." For example, not long ago, the market hit 14,000. You may have wanted to have, say, 60% of your money invested in stocks. But since the stock portion of your investment subsequently went higher in value, it may represent 65% or 70% of your overall portfolio now, instead of the 60% allocation.
It may be time for a "tune-up," or what is commonly referred to as a "re-balancing" of your portfolio. In other words, you need to consider adjusting your portfolio every so often (e.g. every six months) as things change, in order to stick with your original parameters. In the above example, that would mean selling off that extra 5-10% (whatever is above your intended 60% allocation goal for stocks) and putting that money in another asset class. The sum of all of your investments obviously equals 100%.
Determine how much you need to have in each asset class. Re-balance your portfolio every so often to keep the allocations correct, and, from time to time, find out if you need to change your allocation amounts altogether.
Why should all of your money not be in one asset class? Remember what your mother used to tell you. "Don't keep all of your eggs in one basket."
Until the next time, folks, spend your hard-earned money wisely.
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Jason Jovine
Contributing Editor
The Tycoon Report
