Investments: Percentages vs. Absolute amounts.

Jan 14. Spending time with friends

In investing

Practically every  investment website or book talks about investments in percentages terms instead of absolute amounts. They says things like… “you should invest X percentage in stocks and X percentage in Bonds.”

But believe me, investing 50% of your $5,000,000 portfolio in stocks doesn’t feel the same as investing 50% of $50,000.

A person with $5,000,000 could have 100% of his portfolio in bonds. At 2 % he will earn $100,000 per year. No need to think about diversification.

A person with a portfolio of $50,000 invested 100% in bonds at 2% will get only $1,000. This person will have a hard time living out of his investments.

Those are very dramatic differences, yet the percentages are the same.

My approach would be to figure out what is the bare minimum a person needs to live. Let’s say a person lives with $2,000 per month or $24,000 per year. Now, I will make the assumption that the stock market will continue growing the the rate of 8%. Then I will divide $24,000 by 8% = $300,000. I would like to have $300,000 in stocks before I put one single cent in bonds.

One of my friends, his name is Elijah, 32 years old, started investing for the first time this year. His initial capital was $3,000. Does it make sense to have one single dollar of his saving in bonds earning less than 2%? Of course not. I asked him to invest 100% of his portfolio in the Canadian index. As he accumulates more money, we will try to diversify into the US index and some International index.

I have seen plenty of portfolios in which the financial adviser allocates a big percentage of the portfolio in bonds, even if the client has a small amount of money.

In Management fees

Money leaving your hand and into the financial adviser’s pocket

Most actively managed mutual funds in Canada charge 2.5% – 3% as management expenses ratio. On $100,000, that would be $2,500 to $3,000.

When you compare that with the expense ratio of and index fund or ETF of 0.10%, we realize that people who have actively managed funds are getting screwed. The dollar amount an index fund or ETF is about $100.

Of course, financial adviser who work on commission, don’t want you to see the real numbers, they rather work with percentage, they rather keep the figures abstract. It is up to the consumer to do the math to realized how much the adviser is taking out of his pocket.

Conclusion

When deciding how much money to allocate to each asset class, think of it in absolute money amount. And when a financial adviser tell you that he will charge you a “small” percentage for his services, please do the math.

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I am a money coach, don’t hesitate to write me if you want to talk about money or anything else that is going on in your life.

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