The stock market is volatile and risky. I consider risk as a permanent loss of capital. In determining how much of your net worth to allocate to stocks, you have to consider both risk and volatility.
I use a 3 Buckets strategy:
- Liquid assets eg cash. I have 2 years of annual expenditure here. This serves as emergency funds so that I am not forced to sell the volatile assets eg stocks at the wrong time just to raise cash for unforseen situations.
- Safe assets eg govt bonds. I have another 8 years of annual expenditure here. These are assets where the principals are protected. I see them as floor net worth in case all the risky assets tank.
- Risky assets. The balance of my net worth is here equally allocated between stocks and real estate. These are volatile and or risky so you need to learn how to protect the downside when investing.
The amount you set aside for each Bucket will depend on your risk tolerance and other demographics. But I think it is more meaningful than the conventional 60:40 or age rule.
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