2) How Should I Invest my Money/Asset Allocation?

When I first started working as a trust officer thirty plus years ago, you could invest in three options – stocks, bonds, and money market funds.  It was simple. Today it is more complicated.  

Bank investment officers or independent investment officers may describe investments such emerging markets, private equity, hedge funds, market neutral funds, and alternative investments. Common stocks can now mean large capitalization, mid-capitalization, small-capitalization, international, and start-ups. Fixed income can mean corporate, government, international and emerging markets debt.  

As mentioned in an earlier essay, Professor Siegel (Professor of Finance–Wharton School of the University of Pennsylvania) and author of” Stocks For The Long Run,” presented research showing common stocks produced twice the return of fixed income from 1802 through 1997.

Why is this?  Stocks have a return advantage because companies issue bonds (fixed income) and then pay their bondholders a fixed interest rate/amount. Companies use the proceeds from the bond sales to obtain funds needed to run their businesses. If companies can’t put this money to work at a higher rate than what they pay their bondholders, they should go out of business eventually.

If you’re looking for higher returns, I suggest owning stocks. As a stock owner you become a part-owner of business that typically issues bonds to grow.

In addition to the higher rate of return for owners of stocks, stocks can provide tax advantages over fixed income.

Bond interest income is taxed as ordinary income at rates as high 37% vs 20% for stock dividends (qualified). High income individuals may pay an additional 3.8% tax on dividends.

Stocks prices typically go up over time. The increase in price (appreciation) is not taxed until you sell your stock(s). Holding stocks for a long time represents a tremendous wealth building advantage. 

The tax due on the appreciation of stocks (unrealized capital gains) becomes an interest-free loan from the government that stock investors use to increase their returns. This is like the wealth building advantages of IRAs and other tax-deferred investments. 

For long-term investors and especially young investors it makes sense to invest a significant amount of savings in stocks to obtain higher long-term growth.

Getting back to asset classes mentioned earlier.  Diversification (having more than one egg/investment in your basket) is very important and can provide protection from losses.

Owning several stocks or an S&P 500 index fund ETF can provide significant diversification. Investing in several companies or an investment in an S&P 500 ETF, can provide asset class exposure to international, small business, and start-up businesses.

In recent years, index ETFs have become numerous allowing investors with limited funds and those not interested in selecting individual stocks to create diversified low-cost portfolios. There are ETFs for every conceivable asset class.

Options, derivatives, and commodities are used by sophisticated investors.