One of the most frequently asked questions about investments is, “What should I buy, what should I sell, and when?” You may ask, “Is this a good time to buy stocks? Should I be buying bonds? Should I be putting more money in cash?”

The answer to these questions lies in asset allocation.

You probably already understand that you should make a conscious decision about how to allocate your assets. You should decide how you want your investments balanced among, say, mutual funds that own stocks, and bonds and cash reserves.

Any one dollar that you want to invest can do any number of jobs.

It can be poised for growth,

it can help protect you against inflation,

it can help protect you against deflation.

It can be part of the cash in your wallet—

—but it can’t do more than one job at a time.

So we need to make a decision about how much of our money we put in stock and how much of our money that we put in, say, bonds and cash.

That decision about asset allocation is the fundamental investing decision, and much of your investment results will follow from that.

It will also help you answer the question about

what to buy,

what to sell,

when,

and how much.

Let’s suppose that a particular investor has chosen to allocate their assets 50/50.  Half of their money goes into mutual funds that own stock. Half goes into bonds and cash. This gives them a pre-determined balance of how they want their investments to look.

Now suppose there’s a good year in stocks, so their stocks are way up compared to their bonds and cash. When it comes time to re-balance their portfolio—maybe once a year if they’re still accumulating money for retirement—they should make sure that they’re not taking too much risk. So if they’ve got more in stock than their asset allocation calls for, they should sell some stock and put that money into bonds and cash. This can bring their asset allocation back to the 50/50 target that they set for themselves.

Suppose instead it’s been a bad year for stocks. They should probably then look at taking some of the money that’s in bonds and cash and putting it into stock. This will make sure that they’re not taking too little risk in the market.

Notice that just by managing the risk, making sure that they’re not taking on too much or too little, they’re automatically buying low and selling high.

Isn’t that how they told us this process is supposed to work in the first place?

Just by sticking to your asset allocation and making sure that you’re taking on the right amount of investment risk, you’ll automatically buy low and sell high.

This can take a while to come to fruition. You need to be prepared to wait through economic cycles. But you probably already knew that whenever you have any money in the stock market, it’s a long-term investment. And if you think long-term is six months or a year, you’d better think again. Many financial advisors say you need to have at least a five year time horizon to have any money in the stock market. I usually tell my clients they should be thinking about ten. The answer for you will vary depending on your particular circumstance.

How often should you re-balance your assets? Opinions vary. Before you retire, it might be enough to re-balance them every year or so. In retirement, you may need to think about re-balancing two to four times every year.

One more thing about re-balancing. It automatically carries out a contrarian investment style. If your stocks have gone up over time and you’re selling some of them, you’re probably selling when most others have been buying. And the same is true in reverse: if you buy when stocks are down, you’re buying when most others are selling.  There are a lot of investment advisors who say that’s exactly the way to go. Following the crowd is sometimes a way to be disappointed. Following your plan is a good way to help you get to your goals faster, more successfully, and with less risk.

It also allows you to manage your investments in a way that doesn’t take all your time, and allows you to focus on other things in your life. If you’re not worried about investments, that’s good.

Because the moment you stop worrying about money, life gets better.

Copyright © 2009 by Kenneth F. Robinson.