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Asset Allocation

by | | Financial Guides, Financial Independence Coach, The Blog

Asset Allocation

How To Diversify For Maximum Return

Asset allocation-not stock or mutual fund selection, not market timing-is generally the most important factor in determining the return on your investments. In fact, according to research which earned the Nobel Prize, asset allocation ( the types or classes of securities owned) determines approximately 90% of the return. The remaining 10% of the return is determined by which particular investments (stock, bond, mutual fund, etc.) you select and when you decide to buy them.

Consequently, buying a “hot” stock or mutual fund recommended by a financial magazine or newsletter, a brokerage firm or mutual fund family, an advertisement or any other source can be downright dangerous.

Tip: Recommendations in publications may be out-of-date, having been prepared several months prior to the publication date.

As for market timing – that is, moving in and out of an investment or an investment class in anticipation of a rise or fall in the market – it’s been proven that the modern market cannot be timed. Market timing strategies, such as moving your money into stocks when the market is rising or out of stocks when it’s falling, just do not work.

Asset allocation is the cornerstone of good investing. Each investment must be part of an overall asset allocation plan. And this plan must not be generic (one-size-fits-all), but rather must be tailored to your specific needs.

Sound financial advice from a trusted and competent advisor is very important as the investment world is populated by many “advisors” who either are unqualified or don’t have your best interests at heart.

Here, in a nutshell, are the basic investment guidelines you should live by:

Determine your financial profile, based on your time horizon, risk tolerance, goals and financial situation. For more sophisticated investment analysis, this profile should be translated into a graph or curve by a computer program. It’s important to use a good computer program because of the complexity of the task.
Find the right mix of “asset classes” for your portfolio. The asset classes should balance each other in a way that will give the best return for the degree of risk you are willing to take. Using computer programs, financial advisors can determine the proper mix of assets for your financial profile. Over time, the ideal allocation for you will not remain the same; it will change as your situation changes or in response to changes in market conditions.
Choose investments from each class, based on performance and costs.

These concepts are discussed further in the following sections.

 

Note: If the discussion that follows seems theoretical, keep in mind that increasing your investment return by only 2% – with no increase in risk – can amount to a $94,000 increase in the value of a $100,000 portfolio ($307,000 portfolio value at 10% vs. $213,000 at 8%) at the end of 20 years. Even more dramatically, it can amount to an increase of more than $2.2 million on a $1 million investment ($5.3 million portfolio value at 10% vs. $3.1 million at 8%) at the end of 30 years. Is this type of reward worth making the effort to polish your investment approach? The difference in total return, based largely on investing wisely and following the proper principles, can often mean the difference between a comfortable retirement and struggling to survive.