Asset allocation is the modern word for diversification. Itís more
complicated than stocks versus bonds. Itís balancing oneís assets between,
housing, income, retirement, and inheritance requirements. Iím only
addressing the boiler plate asset categories which include real estate,
financial assets, precious metals and gems, as well as personal property.
There are also alternative investments like direct mortgages or venture
capital equity for the more sophisticated investor. Listed below are my
Real Estate - The population doubles approximately
every fifty years causing a constant shortage of adequate housing. That
said, there is a compelling argument that a majority of oneís assets should
be in real estate, in terms of oneís primary residence, income producing
property or vacation property. Keep in mind the three rules of real estate
investing Ė "location, location, and location." Real estate provides three
main financial benefits: (1) leverage, (2) income, and (3) income tax
incentives. On the down side, real estate may require upkeep and can result
in "headaches." Additionally, increasing property taxes and maintenance
costs can literally force property owners to sell. Real estate is also
cyclical and can decline in value. My concern is that as the baby boomers
retire and move into smaller townhouses and condos the larger homes may
become "White Elephants".
Financial Assets - Stocks, bonds, annuities and life insurance
products. The old asset allocation rule, for financial assets, still has
merit. Subtract your age from 100 and that is the portion that one should
have invested in stocks, with the balance invested in fixed income
securities. Remember itís just a guide, everyone is different; consider your
personal situation, goals, risk tolerance, income needs, time frame, etc.
Investors who understand the markets, and have an appetite for investing can
have a larger percentage of their assets in stocks. However, financial
instruments, by their very nature, are risky, and can decline in value
overnight with practically no recourse for the owners.
Additionally, the risk of misplaced or non-existing securities still
exists. I just wonder, if all the reported securities add up to the
aggregate issued and outstanding shares, and are physically secure at
Regarding fixed income securities, using the laddering technique is
prudent. Laddering is stretching out, in equal amounts, the maturity dates
on oneís fixed income investments; therefore, only a portion of oneís
principle gets reinvested in any given year. Laddering smoothes the income
fluctuations on your account; protecting you from rolling over your entire
portfolio in a low rate environment. It also eliminates the game of trying
to predict future interest rates. The negative is that itís rigid and limits
diversification, as well as benefits from an upward spike in rates.
Understanding the yield curve and its implications is also very important
to investors. In a perfect world; the longer the maturity, on government
debt securities, the higher the yield. The steepness of the slope of the
yield curve often determines oneís fixed income strategy. Additionally,
there is also an inverse relationship between the price of fixed income
securities and interest rates. As interest rates go up, market prices do
down and vice versa.
Investors should know the subtleties between inflation protected
investments versus variable interest rate investments. Your day-to-day
bills, and quality of life, are affected more by inflation than interest
Regarding equities, asset allocation is more than placing oneís money in
different investments. It is selectively choosing investments, within the
restraints of your goals and objectives that will balance each other, and
ultimately outperform the market averages. If one is going on the assumption
that you canít beat the averages, but still wants to participate in the
equity markets, then buy index funds.
Diversification is essential, and runs the gamut from small to large
companies, basic industries to high technology, no dividends to high yields,
established to emerging markets, financially sound to bankrupt companies.
The benefits to diversification are that it limits oneís exposure to a
downturn in any particular asset class. It also limits the upside in your
portfolio. Donít over diversify. One can be properly balanced with ten to
twenty securities. Selectively, make your bets.
Investors need both a proper asset mix, as well as good investment
selections. Currently being sold to investors is the idea that the majority
of oneís investment returns are attributed to the mix of asset categories
and not to individual investment selections. Diversification is very
important, but your stock selection is just as important. If your individual
investments donít increase, your overall portfolio wonít either. Investors
are obsessed with their "portfolio". I hope everyone realizes, you only make
money if your individual investments increase in value.
Precious Metals and Stones - In todayís environment it may be prudent
to have 5% to 10% of oneís assets invested in precious metals and gems. Make
sure your valuables are well protected, and family members educated on their
value, and marketability. There is nothing wrong with owning diamonds,
rubies, sapphires, emeralds or gold. For those interested in knowing more
about gemstones and the "four Cs"; Color, Clarity, Cut, and Carat,
Blue Nile.com may be a good starting place.
Personal Property Ė Owning nice personal property is fine and part of
the overall balancing of oneís assets. Living in a half-a-million dollar
house with no furniture is not a good situation. Yet a lot of families are
in that position. Investing in a few antiques, a Steinway piano or oriental
rugs is investing in the quality of your life. Additionally, these assets
may hold their value and even go up in value. Your local antique dealer or
the antique districts in NYC or San Francisco are good places to start
Assets allocation is also the word associated with oneís investment
strategy. Tactical changes to oneís strategy should be made slowly in a
disciplined approach; this may avoid the "buying high and selling low"