As we approach autumn, many farmers are putting up hay. Farmers store hay because they know there might be a harsh winter, or a drought, when there might not be enough grass available for the stock. No one has ever been able to predict when the hard times will come, so farmers simply keep enough hay in storage to ensure they can get through a difficult time when it happens.
This same theory also works well with investments. In the investment business, “hay” = bonds, cash, and guaranteed income contracts. Just like the farmers, we know that the markets can take a downturn at any time. Historically, over the last 100 years, stocks have been down 28% of the time. Over a ten-year period, that would translate to 7 good years and 3 bad years. No one can predict which 3 will be the bad ones. So just like the farmer, we have to lay up some hay to help us through future difficult times.
A case can be made that if an investor won’t need to spend the money for 30-40 years, they can put 100% into stocks and simply ride out the ups and downs. However, unexpected events can cause you to need to spend the funds, even if you are a long-term investor. That is why most of our clients have 20-60% of their portfolios in bonds, cash, guaranteed income contracts, or some combination of the three.
The main reason we encourage investors to keep some non-stock assets in their portfolios is to allow them to liquidate bonds in order to make withdrawals and avoid selling stocks when they might be down. It also helps lessen the emotional fear which occurs during a downturn. There are no guarantees, but so far there has never been a downturn from which a well-diversified stock portfolio failed to recover and rise to new highs. That is a pretty good track record.
We don’t have any reason to believe the stock market should drop any time soon. Companies are expanding, unemployment is down, consumer confidence is up, etc. But just like the farmer has to put up hay in the good times to be ready for the drought, we should make sure we have some stable assets to draw from if a market downturn should occur.
As most of you are aware, we have built these allocations into most of our portfolios already. However, if you have an unusual event or purchase which you know will occur in the near future, you may want to contact us so we can move additional assets into bonds to cover it. That way you won’t be forced to damage your portfolio by having to sell stocks while they are down.
Sources: WSJ, Market Watch