How many of you have a budget?
When I moved out on my own, I lived check to check and most assets were donations from family. Every check was earmarked for the long list of items needed to live independently. I shopped for furniture
by asking friends and family: the parent's old couch; a table from one friend and a chair from another. None of it matched, but the price was right - free. Slowly over time, I built up savings and assets.
Now, when I shop for furniture, I start at a store. Now, I save money from each check.
This growth and maturity and planning is the same for a portfolio.
I started investing in stocks about 12 years ago. My first purchase, after careful research, was Adobe (ADBE). I used a free trade at a discount broker and spent $100.00 to buy two shares. Those two shares cost $95.00.
I used the four guiding principles (as I understood them) of BetterInvesting:
1. Invest a set amount regularly
2. Reinvest earnings dividends and profits - be fully invested.
3. Invest in quality growth stocks and equity mutual funds
4. Diversify your investments
Cash is not mentioned. My understanding was I needed to be fully invested at all times. As I ran the numbers, investing $100 a month into the market would result in lots of transaction fees which would
eat into my returns. I decided to set a threshold of $500 to keep the fees lower. Waiting five months to make a purchase seemed really hard. Stocks were going up and I was not fully invested in the
market. I was in a hurry to build a portfolio. I thought cash on the sidelines was a wasted opportunity. I thought cash on the sidelines meant not being fully invested.
Running a home takes financial planning and a budget. Everyone get this concept. Using a budget allows you to take advantage of sales on the things you need and want. Using a budget allows you to plan for future spending. The same holds true for a portfolio.
There was a great series of articles on Manifestinvesting.com (subscription required, free 30 day trial). An article from June 2010 mentioned the amount of cash being a floating function of the expected returns of the portfolio. Whenthe expected returns are high (stocks are on sale), cash should be low; when expected returns are low (stocks are high in value), cash should be high.
It was an a-ha moment. Of course! It only makes sense that the amount of cash varies with expectations of the portfolio. And a formula makes it even better. The amount of cash ranges from 0%
(everything is on sale) to 25% (nothing is on sale).
As of 10/17, the median projected annual return (PAR) for all stocks followed by MANIFEST is 8.5%. This results in an ideal cash position of 0.25 (1.25 X 0.085) = 0.14375 or 14.375%. My current cash position is 10%. This does not mean I need to sell stock to bring cash up to 14% - but it does mean I am keeping my monthly deposits in cash.