The 50 Percent Rule - A Simple Investing Strategy

OK. Here is the promised simple strategy for investing. In this column, I'll just give the recipe for the strategy, and I'll devote future columns to explaining how it works and how to modify it for different purposes.

The purpose of this simple strategy is to grow your investment at a reasonable rate, while reducing the chance of catastrophic losses. The first part of this strategy has to do with asset allocation. Take all of the money that you have to invest, and divide it into three piles:

• 50% for investing in stocks
• 40% for investing in bonds
• 10% to keep in cash

Investing 50% in stocks is why I call this strategy "the 50 percent rule".

Keep in mind that you should always have six months worth of salary in cash (see my earlier column on the prerequisites to investing). The 10% kept in cash here can count towards that six month salary total.

The second part of this strategy is to use exchange traded funds (ETFs) to minimize the risk involved in purchasing individual stocks and bonds.

• With the money designated for investing in stocks, purchase SPY. SPY is a fund that mimics the performance of the Standard and Poor's index of 500 large cap domestic stocks. It is a broad index that will rise and fall with the overall stock market. It also pays a dividend that is currently running around 1.9%.
• With the money designated for investing in bonds, purchase AGG. AGG is a fund that tracks the performance of the total bond market. Since bonds pay interest, AGG also pays a dividend, which is currently yielding around 3.3%.
  
• The money that is kept in cash will be automatically invested in a money market fund by your broker (see Selecting a Broker).
  

The third and final part of this strategy is to rebalance annually. Over time, the allocations will change. The dividends from stocks and interest from bonds will increase the amount of cash in the account. Fluctuations in the stock market will cause the value of your investment in SPY to increase or decrease. The same is true with AGG.

Once a year, you should correct the allocations to bring them back to the recommended percentages. For example, if the stock market has declined, and the bond market has rallied slightly, after a year your allocation might look like this:

• 45% SPY
• 41% AGG
• 14% cash

This means you should sell enough AGG to reduce its allocation to 40%, and purchase more SPY, to bring its allocation back to 50%. That is called portfolio rebalancing.

This rebalancing should be done once a year. I do it at the end of January or beginning of February each year, because that is when most companies report their annual results.

So that's the whole strategy. As you save money, you can add it to cash, and let it be rebalanced into other investments annually. If you need to raise money, take it out of cash. Don't let the cash level drop too low, however. If it falls to 5%, you should do a rebalancing to bring it back to the 10% level.