Asset Allocation

  • Select the asset allocation mixture on your investments carefully. This means understanding the risks that are involved (primarily market risk and inflation risk). Educate yourself on the matter through independent experts who teach instead of sell. Once you know what the right allocation is for you; set it and leave it alone. You will want to answer these questions:

 

  • What is my time horizon? Ask yourself when exactly will you need the money?

  • How much risk can I handle without freaking out? Basically, how big of a drop in your portfolio would cause you to sell?

  • What are my goals? What is this money for? This might be retirement, college for the kids, a home, etc…

  • What is my tax situation? Focus on retirement accounts to tax shelter the money. High income folks consider tax-exempt funds.

  • Do I need income? Are you retiring and needing money to live on or are you simply in the contribution phase?

 

  • Read The Four Pillars of Investing, by William Bernstein. This book will provide you a good foundation of knowledge that will help you with this very important decision. Asset allocation is a pretty simple concept once you become educated on the matter and understand how to separate your investments in a cohesive and understandable way. Your asset allocation should work hand in hand with your financial plan that contains your short and long-term goals.

 

  • John Bogle, author of The Little Book of Common Sense Investing and Common Sense on Mutual Funds provides a simple approach to this issue. Use your age to identify what your bonds and cash allocation should be. If you were 35 you would have 35% of your investments in bonds and cash and 65% of your investments in stocks. Mr. Bogle is a very wise and experienced man. Mr. Bogle would tell you this is a pretty conservative allocation, but he would also tell you that many people are not as risk averse as they think. I value his assessment.

 

  • Once you have selected your asset allocation, place that money in no-load index funds. You can find a list of recommended funds on this website. Once you become truly educated on investing and discard your ego, you will see the wisdom of investing in these types of funds. Keep it simple.

 

  • Purchase your assets, allocate them appropriately, and then leave them alone. Your asset allocation model is not to be touched until it is time to rebalance them. This means no timing the market. No listening to the TV pundits. And definitely don’t listen to Billy Bob in the break room at work. None of the advice these “experts” spew out is worth a hill of beans!

 

  • Rebalance your investments no more often than 1 year. This simply means you go in and sell some bonds or stocks to get you back to your designated allocation. You can also do this by simply adding more money to different accounts throughout the year. You should avoid selling in taxable accounts because of the tax consequences. Focus on your company retirement plan and your Roth IRA when rebalancing.

 

 

  • These are historical averages and will not tell you what your return will do in any given year. What it will do is help you see how different asset allocation models compare over the years based on how many stocks or bonds and cash you have in your portfolio. Use this as an educational tool to further your understanding of asset allocation.