Day 12: Allocate Capital Like a Pro
Degree of difficulty: Moderate to difficult
It's day 12 on the road to financial fitness, and if you've been with me from the start, you're really getting warmed up. So let's take on a more rigorous--but extremely important--task: allocating your household's financial capital.
Although Morningstar focuses on helping you invest in stocks, funds, and ETFs, the reality is that investors' highest-impact decisions precede the decision to invest in the market. The main issue is about capital allocation: Do you save enough? And when you have extra cash on hand, do you pay down debt, invest, or do a little of both?
When it comes to the latter decision, it's helpful to think of yourself as a business owner, steering your cash toward the opportunity that is apt to offer you the best return on your capital.
Paying off debt--even more benign types of debt like mortgage debt or student loans--offers you a knowable return on your money--always a good thing.
Investing in the market offers a potentially higher rate of return, but the hitch is that return, unlike paying off debt, isn't guaranteed. When forecasting returns for your investments, be conservative. You can plug in your own return expectations, but I usually use a 6% to 7% rate of return for equities, a 4% return for bonds, and a 2% return for cash. Based on the asset mix of your portfolio, you can then forecast a ballpark return for it. Armed with that information, you can then determine whether investing in the market or paying off debt is the best return on your dough.
My book, 30-Minute Money Solutions, includes a section on finding the best use of your money, as well as a worksheet to help you sort through the variables.
Return to the article: "The 30-Day Financial Fitness Plan".
