Allocation of returns answers the question, "What do I do with the money that I make from my investments?" It is a question often overlooked by many investors and can have a far reaching impact on both your wealth and quality of life if ignored. The concept of the risk pyramid tells us that we must always have a base, or foundation, that can support our investment portfolio. A strong foundation begins with an emergency fund of cash or other easily accessible savings. We recommend that you establish a fund of readily accessible cash equal to a minimum of three months and preferably six months of total living expenses, especially during times of economic distress. These funds will be used for emergencies, unexpected bills or sudden unemployment. We also recommend that you have adequate insurance to protect you and your loved ones from illness, injury or any other catastrophic loss. Emergency savings and adequate insurance form the foundation of any solid financial plan. Before you begin building or increasing a high-risk investment portfolio, you must first establish a base strong enough to support the growth. Therefore, a portion of all returns received from higher risk investments needs to first be allocated to the accelerated elimination of any high interest debt (higher than your expected return on investment. See “the three factors of investing”) and second, to lower risk investments, which are often investments included in the base of the pyramid. For example, you should not establish a substantial high-risk investment portfolio while paying on high interest consumer debt as there is little chance that you will make more than the average 18% on credit card debt. Or, maybe you are still paying on some lower interest debt but decide to invest $20 each month into a few penny stocks that you have been following and have consistently returned between 20% and 30%. Any profits earned from your high risk investments need to be allocated to the accelerated elimination of your debt until all high interest debts have been eliminated. Once all high interest consumer debt (credit cards, signature loans, most medical debt) has been eliminated, you can begin to allocate any profits to increased emergency savings, insurance, and finally to lower risk/lower return investments. Don't make the mistake of over building your investment accounts without first taking care of the financial necessities. By properly allocating your returns, you can safeguard your future and ensure financial success. Author
Chad Sunyich |
