This month we are going back to the basics with a refresher on the topic of asset allocation. If you are not an investment advisor, it may be a term you are unfamiliar with, especially if you don’t engage with an advisor to manage your assets.
You won’t hear asset allocation discussed much on CNBC and you probably won’t find it to be the topic of a Yahoo! Finance article. It’s not an exciting or “sexy” topic and therefore it doesn’t sell. The latest hot stock, the end of Europe as we know it, and “What’s going on with Facebook?” are what sell news and drive many to make investment decisions.
Unfortunately asset allocation should be the cornerstone of any investment decision. A proper strategy can help you meet your goals regardless of if a stock is hot or not. The concept is very simple. Just as the old saying goes, “Don’t put all your eggs in one basket”. That’s what asset allocation is all about.
Say for instance you get a hot tip on a stock and place your retirement fund in it. If the news turned out to be bad and the company went bankrupt, you lose – everything. But, if you thought the hot tip had some validity to it, maybe you put 5% of your retirement in it. Then if the news was bad, you may be behind, but you still have 95% of your retirement.
Asset allocation is about spreading out your investment portfolio amongst a number of different asset classes to create a managed and effective way to reach your goals for that portfolio. Large cap stocks, small cap stocks, corporate bonds, commodities, and real estate are all examples of different asset classes. Some move similarly to others, some move in completely different directions. This concept is the “correlation” of the assets classes. The idea here is that no one bet will sink your investment plan and it’s very likely that in almost any time period one of your asset classes will be performing positively, or at least helping maintain some stability. A top performing asset class 1 quarter, might be at the bottom the near future as the following chart illustrates.
Mackey Advisors™ investment portfolios usually contain anywhere from 10 to 15 different asset classes. The weighting put on each class is dependent on a variety of factors; expected short & long term performance, the global economy, historical sector movement, current phase of economic expansion or contraction, are just a few of the factors that might help determine if “large-cap growth” stocks are 5% or 15% of an investment portfolio.
Each asset class also has a certain amount to volatility associated with it. If you are closer to reaching your goal for a specific portfolio, or just don’t like your investments changing rapidly, the basis for your asset allocation might be how much to have in stocks and how much to have in bonds. If you are drawing income from the portfolio, this is also a factor. Once you decide this split, then you can work and decide where in stocks and where in bonds you should be.
The chart below is a template some people will use to help understand what asset classes to consider and how to split things up.
Of course to be a successful “do it yourself-er”, it is important to stay on top of news and make changes to your model. As time changes one asset class will go out of favor vs. another and will need to take up a lesser portfolio of your model. As your portfolio moves, what you said should be a 5% exposure to real estate might become 10%. Rebalancing will keep your desired model in balance and make sure you are buying and selling when you should and not when your emotions tell you.
So I hope that wasn’t too boring or too intense, and hopefully you will find it helpful as you work with your advisor or navigate the management of your own portfolio. This one of our core competencies at Mackey Advisors™ and while we aren’t in the business of too much free advice, we would be more than happy to sit down with you, learn about you, and explore how portfolios can be built to achieve the dreams you always wanted.