Dividing assets by time horizon. A three-bucket approach is described where assets are divided to provide income in three phases: short-term, intermediate-term, and long-term How to Ride the Wave. Outlook for continued US economic expansion; US monetary policy; Investment in high technology stocks; Cash and bond holdings; Stocks and stockowning mutual funds; Personal debt. What women want: Financially speaking, businesswoman in transition gets case study makeover. Discussion on asset management; Information on investment portfolio of stocks and bonds; Details of their retirement plans.
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But by approaching forecasting as a disciplined process rather than a guessing game you can avoid some common mistakes and improve your chances of meeting your goals. The pitfalls of history. The most common forecasting faux pas is extrapolating past returns into the future. The problem with this approach is that you can come up with wildly different projections, depending on which slice of history you select. How much money will you have available for tuition, books, pizza parties and the like in ?
But what if stocks return an annualized 7. And if we get 15 years like those ending in , when stocks gained just 4. Bye-bye Ivy League. Averages can mislead. But these examples raise an even more subtle flaw beyond over- or underestimating returns.
Stocks and bonds deliver great gains some years, lousy ones in others. So those precise figures that calculators spit out are really a fiction. Over the next 30 years, such a portfolio would have earned an annualized But as the chart on page 53 shows, the size of your account depends on how you earn those returns. If you had earned In short, even if you get the average return right, you can end up with more or less than you expect.
How then can one plan in the face of so much uncertainty? Start with realistic assumptions. For reasonable expectations about future stock gains, look first to the two main building blocks of equity returns--earnings and dividends. After all, says Roger Ibbotson, Yale finance professor and chairman of Chicago research firm Ibbotson Associates, "the returns we ultimately get depend on what corporations can deliver.
Add the recent dividend yield of about 1. But these figures are just a baseline. If your portfolio includes a dollop of small stocks, you might boost your expected return a bit. Similarly, you might make adjustments depending on your outlook for profit growth.
Ibbotson expects earnings to grow at a slightly higher rate than in the past, in part because companies now pay out less of their profits in dividends, leaving more capital for future growth. For this and other reasons, he forecasts a long-term return for stocks of about 9. Think probabilities, not certainties. Whatever return you arrive at, the odds of its being right on target are minuscule.
What are your odds of pulling this off? You can also see how altering assumptions such as your savings rate, retirement date or asset mix changes the odds of your reaching your goal. A few other sites can also give you a sense of the range of probabilities involved in forecasts. Financial Engines www. And one site, financeware. Diversify to increase your odds of success. Spreading your money among a variety of different types of stocks, as well as bonds, not only lowers the volatility of your portfolio; it also narrows the range of values your portfolio might hit in the future.
Monitor your progress. You might need to increase your stock exposure. Or boost your savings. Or do both. So plan early, check your progress often and make adjustments as needed. You can reach him at investing moneymail.
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