Friday, August 3, 2012

Stock Talk - The Defensive Investor Allocation

Continuing on with the book The Intelligent Investor, the book writes about what the Defensive Investor should include their portfolio.  Recommending that you divide your funds between high-grade bonds and high-grade stocks.  The book goes on to discussing that stock-bond allocation should be something that is considered to remain on the defensive. 

What is defensive?  Well, do not want to have a negative return in any given year.  The book talks about never having less than 25% in common stocks and never over 75%.  It goes on to say how difficult this can be because when markets will your portfolio.  If  you have a strong enough market move in either direction you can easily fall out of bound either way.

One method of keeping this allocation would be the 50-50 approach.  When your stock allocation increases to say 55% then you would sell 1/11 of your stock portfolio and switch it to bonds.  Thus if your portfolio would fall to 45% then this would require you to sell 1/11 of  your bond fund and buy stocks.  Benjamin Graham felt this was a rather simple approach to creating a portfolio.  You could simply do this by purchasing a bond and stock index fund or just a stock index fund and buy bonds individually.  This might be a cheaper route.

This could be using Treasury Direct which is a place to buy government bonds directly.  The book on page 93 even discusses U.S. Savings Bonds.  It discusses that for a period of many years the only sensible bond purchases for individuals were the U.S. savings issues.  The safety is unmatched, and the rate of returns are higher than other bond investments of first quality.  The interest rate for the Series I bonds are 2.2% through October 31, 2012.  For something that can be easily converted back to cash, I find it hard to beat.

An example of how this could work would be if you had $10,000 to would buy $5000 in Series I bonds earning currently 2.2%.  This would make you $110 per year if rates remained the same.  If you purchased a large index fund such as SPY you would receive 35 shares @ SPY current price closing at 139.35.  You would still have some change left over.  You would receive a dividend of around $99 from the stock if the yield remained at 1.98%.

This is just an example of how you could build a portfolio as a defensive investor.  Personally, I do not like allocating all assets into cash, stocks and bonds.  I prefer to look for undervalued assets and would not want to exclude gold, silver, and real estate.  More importantly...I currently investing all of my disposable income towards paying off my residental home.  I feel that not be in debt is much safer investment and will yield a greater return than bonds can currently.  I do own Series I bonds, however they have been yielding over 4%.

If you have a mortgage of 4, 5 or 6% chances are from a defensive investor approach you will have a harder time acheiving yields better than you would if you paid down your mortgage, credit cards, or car payments.

Disclosure: Military Millionaire does not own any of the stocks mentioned in this article.  Military Millionaire does own Series I bonds.

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