|
|
 |
|
Fundamentals of Asset
Allocation
|
| Asset Allocation is a
planning tool, not an investment strategy... few investors take the time to
appreciate the distinction between the two. The paragraphs below contains what
I would like to think most experienced
Investment Managers would consider the fundamentals of Asset Allocation.
|
| Asset Allocation is the most
important and most frequently misunderstood concept in the investment
lexicon. The most basic of the many confusions
surrounding Asset Allocation is the idea that
diversification and Asset Allocation are one and the same.
Diversification takes place within the Asset Allocation divisions, or
buckets.
Next
in line would be the fallacy that Asset Allocation is a sophisticated
technique used to soften the bottom line impact of movements in stock
and bond prices. A similar idea proposes that Asset Allocation is a
process that automatically (and foolishly) moves investment dollars from
a weakening asset classification to a stronger one, a subtle market timing device.
Finally, there is
the very widely accepted myth that a properly designed Asset Allocation
formula must include a percentage of cash.
Asset
Allocation is so much simpler than any of this.
|
| Still, because of it's Buzz Word status and
general acceptance as a valid investment concept, a warehouse full of
Asset Allocation models, programs, software products, seminars, books,
gurus, and worksheets have evolved. The
ultimate purpose of the Asset Allocation tools is to sell investment products,
various types of analytical software (crystal balls), and an assortment
of speculative
vehicles... that the providers feel are safe to use in 5%
increments.
And then there are the specialized Asset
Allocation computer programs that process your personal data and
propensities and then (after a few days so that you'll think it is more than just
boilerplate) spew out a glossy personalized Asset Allocation
presentation that could have as many as 20 different decimal
pointed classifications and sub-classifications that your financial
advisor will be pleased to fill up with his favorite investment
products.
Proper Asset
Allocation avoids all of this stuff, or it certainly could.
|
The basic Asset Allocation
formula can be a kitchen table plan outline, developed by
crunching very few numbers in tandem with a consideration of very few ball park answers to some pretty basic,
common sense,
questions. At retirement, for example:
- How much do you have to
invest?
- How much income do you have
from pensions, Social Security, etc?
- How much additional
income will you need?
Asset Allocation is not complicated or mysterious,
nor does the development of a workable Asset Allocation formula require
the (fee based) assistance of an RIA, CPA, CFA, CFPC, or any other
similarly designated sales representative or fee based Asset Allocation
Specialist.
I don't mean to diminish the importance of having an
experienced and skilled advisor to help you with your Asset Allocation
decisions. Just be careful not to use someone who either has products to
sell or a referral fee arrangement with someone who does. Any
arrangement of this nature must be disclosed to you... ask the question,
check out the response.
An Asset Allocation Formula
needs to be flexible, and flexibility is easier to achieve with
individual securities than it is with products and contracts. Most
advisors have a good working knowledge of packaged products, and very
little experience with individual securities and their goal directed
management.
As thousands of people have learned after reading
The
Brainwashing of the American Investor,
Asset
Allocation is so simple that anyone can do it.
|
|
The Asset Allocation formula is the skeleton of the
Investment Plan and, without it, the investment process is
directionless, disorganized, and destined for failure. The
Asset Allocation process should divide the available investment assets into
two (and only two) classifications: Equity investments and Income
investments. Cash balances will, and should, accrue but they must be
reinvested appropriately.
After consideration of
such things as age, guaranteed retirement income from outside sources,
projected annual expenses, planned retirement dates, and other goals and
objectives, the Income portion of the
Asset Allocation formula is always developed first. The remainder of the investment
portfolio becomes the Equity Asset Allocation.
Asset
Allocation formulae must be simple if they are to be
manageable, by a human being.
|
Asset Allocation
considerations that you must be familiar with are these:
- any
six figure portfolio, at any age and regardless of any other
considerations, should have an Income component of at least 30%,
and
- all Asset Allocation maintenance calculations absolutely must be
based on the cost basis of securities and not on their current market
values.
- Additionally, the Smart Cash and/or Money Market
balances that inevitably appear in a properly managed investment program
must never be thought of in non-Asset Allocation terms. Every dollar
(emergency cash should be kept elsewhere) is being held temporarily
while you look for investments that belong among the securities that are
currently in the portfolio.
An Asset
Allocation formulae with percentages that are not evenly divisible
by 5 (or which includes decimal points) is a sales tool, and possibly
the product of a sick computer programmer. K. I. S. S.
|
|
Investing is the process of
filling up the two Asset Allocation buckets with securities,
using a single investment strategy in a disciplined and consistent
manner. If you are thinking of trying a strategy for a year to see if it
works, you've missed the point, and are confusing strategy
with gimmick.
Running an Asset Allocation plan
requires the use of a strategy that can stand up to stock market and
interest cycles, with all of their wonderful fluctuations and uncertainties.
The strategy should not be based on
future prediction or on any promise of unusually high rates of return,
and the Asset Allocation formula absolutely must not be tinkered with
based on one's perceptions of market conditions.
The Asset
Allocation must be flexible (and the securities liquid without penalty
of any kind) so that gradual changes can be made in response to changes
in personal circumstances. Absolutely never violate the Asset Allocation
Formula because of changing conditions in either the stock or the fixed
income markets.
The past twenty years or so have changed
investing from an personal decision making process into
a product shopping mall... confusing, expensive, inflexible, and impractical. You owe it to yourself to get some
basic education before you go there.
You'll
find that you simply have to.
|
|
In
Investing, Quality is Job One in Any Asset Allocation Formula.
|
|
