In the mid-1980s, I worked at a pharmaceutical company, the stock of which was en route to a 2,000%, six-year gain. In Year Three of this upsurge, I suggested to an acquaintance, then a member of the Forbes 400 (the magazine's annual identification of the nation's richest people) that he might consider investing in the stock, since securities analysts remained so uniformly optimistic.
My 65-year-old friend didn't say no, but neither did he seem particularly interested. I didn't get it. This guy was worth hundreds of millions, and just as my employee stock options and every other dime I had invested were surely going to make me, by the tender age of 35, worth a few hundred thousand, it would likely catapult this fellow high into the Forbes rankings, perhaps even to billionaire status.
Why wouldn't he want that? I mean, I could show him the analyst reports, unanimously captioned "Strong Buy" only because "Fanatically Strong Buy" was deemed unseemly by brokerage managements.
Three decades later, I get it. In his circumstances, he had no motivation to invest in any given high-growth stock, even if persuaded that the fundamentals were solid. There were myriad other reasons as well. After all, as the CEO of one of the largest private companies in the country, he had plenty of profitable irons in the fire, and didn't need one more thing to think about.
But I suspect the chief reason for his lack of interest was a learned and implacable aversion to losing the family fortune. A recognized and generous philanthropist, he was, however, notoriously "selective" about the willful surrender of his money. He already had wealth and really didn't need more. But more importantly, he didn't want to ever lose it.
One needn't be worth hundreds of millions to hold this sentiment, and indeed, anyone who has accumulated sufficient wealth would be foolish to renounce that view. After all, as the aphorism cautions, "If you've won the game, why keep playing?"
In the context of personal investment management, this must be regarded as more than a rhetorical question. In fact, it should be the signature consideration upon winning the game. Anyone who has reached "critical mass" -- i.e., sufficient wealth on which to live without ever working again -- must absolutely stop playing the "growth" game to ensure that the critical mass will remain intact. (Of course, any extra "mad money" in one's pocket can be always thrown at growth investments, pink-sheet stocks, junk bonds or Lotto tickets.)
In short, winners of the game must invest conservatively, which can be a difficult adjustment for people accustomed to decades of investing in growth stocks. But they must do it. They have to suppress their developed instinct to invest for growth. Otherwise, all that they have gained over a lifetime could be lost at the whim of any number of catalysts: a one-day stock market crash; an excruciatingly, nearly imperceptible, years-long bear market; or simply specific-stock risk.
Too pessimistic given the 15% market rise this year? Not from where I stand. And what if we all soon find ourselves standing on the edge of a fiscal cliff?
Not only is safe asset allocation always a mandatory practice for those who have won the game, but it should be noted that stocks this year have risen mostly on the back of unprecedented and incessant central bank accommodation that is, contrarily, not having its desired effect -- i.e., causing businesses to invest or consumers to save. That's not an economic outcome that can sustain a rising market.
To keep their wealth intact at this time, those who have won the game should keep a core portfolio of short-term bonds. Here's a sample allocation: 70% in Vanguard Short-Term Corporate Bond Index ETF (NASDAQ:VCSH); 20% in Vanguard GNMA Fund (MUTF:VFIIX); 10% in Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ:VTIP).
Simple and quite reasonably safe, without capitulating to maximally safe but virtually no-yield Treasurys.
VCSH yields only 1.21%, but has an average maturity of just three years, so the fund manager is able to readily reinvest in newer, higher-yielding corporates as interest rates rise. The average credit quality is a perfectly acceptable A.
VFIIX yields 2.8%, and has an average maturity 5.5 years that cannot be considered short term. But that's not too much longer, and it's just 20% of the portfolio. Plus, it has a beta coefficient of 0.72, meaning it has low price volatility, and an average credit quality of AAA.
VTIP yields a big fat 0%, but all of the Fed's cash spilling onto the sidewalks will surely lead to a rise in inflation. This 10% allocation could as easily be stored in cash until that time arrives, but having it secure on the inflation launch pad vs. reaping all of 0.01% in a money-market fund is the preferred choice. No reason to miss the lift-off.
I know, you're about to protest that stocks have to be in the mix in order to keep pace with inflation. To the contrary, interest rates usually keep up with inflation quite adequately. And with short-term holdings regularly being reinvested at maturity, a conservative portfolio is fully capable of maintaining inflation-adjusted value without a stock component.
And yes, it's tempting to allocate a sliver to high-yielding junk bonds or mortgage REITs, just to boost the yield a bit, but this discourse is about optimal safety. Any relaxation of that rule is for another column.
Disclosure: I am personally long VFIIX. Gerard Wealth Management owns shares of VCSH in its Stable High Yield model portfolio at Covestor.com. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.