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Asset Allocation

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 observations:

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 financial institutions.

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 rates.

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 looking.

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" scenario.


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