Chapter 4. Equities

Equities versus Fixed Income

This is the most important asset allocation decision and the primary determinant of the expected return and risk of an investor's portfolio. We will now examine reasons why an investor should consider having a higher or lower equity allocation.

Reasons to Increase Equity Exposure

  • Longer time horizon. Younger investors have more human capital (more future labor income) to offset investment risk. In addition, investors with longer horizons have the ability to "wait out" a bear market without being forced to sell in order to meet cash-flow needs. This is especially true for investors who are still working. The longer your time horizon, the less likely equities will underperform fixed income investments.

  • High level of job stability. This is particularly true for individuals with income from jobs having little or no correlation to the economic risks of equity investing and the economy in general. A doctor or a tenured professor has income with bond-like characteristics. The income of an entrepreneur, whose business is affected by the performance of the stock market or does poorly when the economy is doing poorly, has equity-like characteristics.

  • High tolerance for risk. These individuals may have a full understanding and faith that in the long run, they will likely be compensated with higher returns for the increased risk. Or they may simply not watch their accounts closely. Most importantly, they are willing to accept the consequences if returns ...

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