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Asset Allocation is an
Investment Planning Tool,
not an Investment Strategy... few investment professionals understand
the distinction. Investment Strategies are used to select and to
manage the securities that are "allocated" to either the
Equity or Income Asset Allocation buckets.
Investment Planning involves an understanding of the
basics of Asset Allocation, most of which can be
found in the pages of The
Brainwashing of the American Investor.
Investment
Planning and Financial Planning are two totally
different concepts... the latter being the broader of the two, but a
Financial Plan may or may not include an Investment Plan, and an
Investment Plan (even without a Financial Plan) is essential before
even the first minor investment is made.
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| In the beginning, there was
money! And the investment gods, in their infinite wisdom,
created the corporation with it's two forms of capitalization:
Stocks and Bonds...ONLY Stocks and Bonds. Corporations raise money by selling shares of ownership
called stocks, and a variety of debt instruments called, for
simplicity, bonds. They use this capital to run their
businesses, and investors can participate in the future of a
business by purchasing legal instruments called securities. Market
places (such as the NYSE and the NASDAQ) have evolved to allow
investors to exchange (buy and sell) their ownership and creditor
positions. Asset Allocation is the process
of planning how an investment portfolio is to be divided between
these two classes (and only these two classes) of investment
securities. This planning step should be the first step in developing any
investment portfolio, well before the first security is
purchased.... but it rarely is.
Thus, determining an appropriate Asset Allocation Formula is a
Management Task. PLANNING! |
Many investors, and even a
large number of Investment Professionals, think that
Income
Securities have some claim to price stability in addition to their
role in providing present or future disposable income!
They just
don't, and their prices will fluctuate in either direction
(sometimes violently if there is considerable confusion about the
direction of interest rates). These price movements are always
good for investors because of the opportunity they provide either
to:
- Add to existing holdings to decrease
cost basis and increase yield on investment when prices fall.
- Sell existing holdings for Capital
Gain Profits when the proceeds of sale can be invested at higher
Current Yields and/or the net profit exceeds the Current Yield.
The Market Value
of
an Income Security
is totally irrelevant to the investor, so
long as the quality of the issuing entity has not deteriorated
significantly. The media has not helped
in communicating this fairly logical message to investors, and most
will look at you funny when you express the opinion. So when the
subject comes up, just nod, smile, and go add to your Income CEF
holdings.
(For
more on Income Investing, click here.) |
| Asset Allocation
planning
is, by it's very nature, a personal, goal directed activity.
Every investor comes to the investment process at a different stage
in life, with different investment resources, different retirement
plans and objectives, different family responsibilities and
expectations, different pension and profit sharing benefits, and
differing emotional and physical health conditions...to name just a
few of the possibilities for differing Asset Allocations. Age,
current liquid assets, purpose or objectives, beneficiaries of the
program, retirement prospects, etc, all play a part in the
development of the Investment Plan. Investors may well have
several plans in operation at the same time, in different investment
portfolios, and with different asset allocations. Not
the ideal environment for one size fits all mutual fund products.
Asset
Allocation Mutual Funds? Oxymorons. |
| Many investors confuse Asset
Allocation planning with one of the very basic Principles of
Investing, Diversification. (The
other two investment basics are Quality and Income generation.)
Diversification is a risk minimization technique that comes into
play when the investor actually begins to purchase securities to
fill in the the Income and Equity buckets of the
portfolio.
There are several types of diversification, but the
more important ones are: the size of individual security positions
and the total size of security group positions (i. e., drugs, oil
services, automobiles, etc.). International diversification is
best taken care of through investment in multinational US companies.
Market capitalization variations, beta numbers, all shapes and sizes
of future guessing securities, indices, commodities, and other Buzz Word type classifications of assets are merely
methods for selling different forms of investment products, not asset
allocation categories... there are
Stocks and there are Bonds.
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| An Asset Allocation Formula
is a long-range, semi-permanent, planning decision that has
absolutely nothing to do with market timing or "hedging"
of any kind. Sure, a 40% asset
allocation to Fixed Income may soften the fall in the portfolio
bottom line during a stock market downturn, but that has nothing to do
with the purpose of Fixed Income Securities nor is it in any way
related to the reasons for having an asset allocation plan in the
first place. Similarly, the movement of a person's assets from a
falling bond market to a rising stock market or vice versa is about
as far away from the principles of asset allocation as one can get!
Market Timing efforts such as these are detours from
the Investment Plan... the investment gods frown on such activities.
If you focus exclusively on market
value, dwell upon comparisons of your unique portfolio with
Market Averages, expect "performance" during specific time
intervals, and listen intently when someone speaks about the future,
any asset allocation work you do will be ineffective. (Please
reread that last thought.)
If you focus exclusively on "market
value", dwell upon comparisons of your unique portfolio with
Market Averages, expect "performance" during specific time
intervals, and listen intently when someone speaks about the future,
any asset allocation work you do will be ineffective. (Gotcha!) |
| Cash is not an investment
and, therefore, is not a class of assets within an Asset Allocation model.
Most entities that include
"cash" in their portfolio mix use it as a hedge against
market movements in one direction or the other... in the future.
Smells like Market Timing again, but, ironically, the cash reserve
will generally be reallocated to the bucket that is
increasing in price. Hmmmm.
I need a show of hands. How many of you
believe that anyone can predict the future? I do not expect a full
email box.
"Micro", "mini", "large",
"emerging", "growth", "income" are not
sub- classifications of equity securities that demand a separate
Asset Allocation number. There
are stocks (equities) and there are
bonds (income).
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| Real Estate certainly has a
place in an investment portfolio, one that can be both conservative
and/or more speculative in nature. The rules of
Diversification are as valid in Real Estate Investing as anywhere
else. Where the primary purpose of the Real Estate (to the
investor) is Income generation, as with most REITs, and rental
properties, include the cost basis in your Income Asset
Allocation. If you purchase raw land or own buildings that you
intend to sell, these are best placed in the Equity portion of the
Asset Allocation because of their riskier nature.
There are absolutely, unequivocally,
NO GUARANTEES that the price of
your
Real Estate will increase rapidly. There are many
factors at play in this market just as there are in any other. The
primary ones are: Location, Location, Location... and Interest Rate
Expectations.
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| Neither Asset Allocation nor Diversification
decisions should be based upon Market Value numbers. The cost basis of the securities in question must be used
for consistent decision making in all market environments. You
will probably have trouble with this new approach, which is the key
element in The "Working Capital Model",
an Asset Allocation concept/tool developed by Professional Investment Manager
Steve Selengut. (I sometimes think that I'm the only one who
understands it, but that can't be possible.)
Asset Allocation works
particularly well within an Investment Management approach that uses
Working Capital as the basis for both Allocation and Diversification
decisions. This approach provides the investor
with an easy way to analyze both Asset Allocation and
Diversification simply and regularly. It also facilitates year to
year progress analysis, without consideration of the vagaries of
market value determination. It suits any asset allocation formula.
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