Consider Goals, Not Wishes, Before Developing An Investment ProgramConsider Goals, Not Wishes, Before Developing An Investment Program

The hardest aspect of the financial markets is trying to call top and bottom prices. That's why market timing usually results in losses for the average investor. This is especially true for technology investors focused on one sector of the stock market.

IT managers often ask me about the stock market, and they always ask about specific technology stocks. There's nothing wrong with asking about a specific company, especially if you're doing a request for proposals or thinking about licensing technology. This is part of the due diligence process. However, most managers ask whether the stock has hit bottom or when it will recover. Now, most of the IT people I meet are quite intelligent about their field of expertise, and I doubt they'd make technology implementation decisions based on a rumor or a hot tip--but they'll do that with their personal investments.

Why the disconnect between good logic and emotion? Simple: fear and greed, two basic human emotions. The runaway year of 1999 let people forget fundamental financial rules and still make money. Last year, many investors were surprised when they lost money. Technology investors are now faced with having to sell at a loss. They want to know whether they should hold on, buy more of the same stock at its lower price so it fills the same proportion of their investment portfolio, or sell, but these are the wrong questions to ask in the current environment.

First, I ask investors, including IT professionals, for their personal financial goal. Is it to retire at age 65, 62, or 59? Is it to pay off the house by the time they retire and have $60,000 per year in current income in constant dollars (adjusted for inflation)? Define these types of goals first. Doubling your money on a stock may seem like a goal, but it's really more of a hope or a wish.

Second, ask yourself what's the appropriate asset allocation that will generate enough of a return, along with additional savings, to achieve the goals in the designated time period. This will include asset classes such as domestic U.S. equities (both large-and small-cap stocks), international equities, bonds or other fixed-income instruments, real estate, and cash, to name a few. As the last three years have shown, the importance of having different asset classes is that no one asset class stays on top forever. By diversifying, you reduce portfolio risk while increasing overall portfolio return commensurate with the risk taken.

For example, a couple in their mid-30s might take more risk than an older couple, so they would have an asset allocation that looks like this: 45% large-cap U.S. stocks, 10% small-cap U.S. stocks, 15% international stocks, 10% real-estate investment trusts, 15% bonds or other fixed-income investments, and 5% cash equivalents and money market. This might result in a long-term return of 10% to 11% with a standard deviation of 9%. This means that in two-thirds of all years, an investor will likely have a portfolio return that will range from 2% to 20%. Notice that there are still a third of all years where the returns are outside those limits. The asset allocation decision dictates 80% to 90% of total portfolio return over the long-term, according to most academic studies. But most investors I know spend less than 10% of their time on this decision.

Third, make sure you regularly rebalance back to target weightings. This ensures that you can buy low and sell high without getting caught in the over-or under-valuation question for an individual security.

The last question to ask is what individual securities you should own. The easy answer is broad-based, diversified mutual funds. Remember that tech stocks represent only about 20% of the S&P 500, the U.S. large-cap stock index. Tech funds, by definition, are subsets of one asset class. If you invest in a pure tech fund, understand that you're making an overweighting within a sector of an asset class.

Most investors will come out ahead following these simple financial principles. The difficulty, as in most things, is in the execution and follow-through.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the information 100 Stock Index. Reach him at [email protected].