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Fundamentals of
Asset Allocation
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| Asset Allocation is a
planning tool, not an investment strategy... few investors
take the time to appreciate the distinction between the two.
The paragraphs below contains what I would like to think
most experienced Investment Managers would consider the
fundamentals of Asset Allocation. |
| Asset Allocation is the
most important and most frequently misunderstood concept in
the investment lexicon. The most
basic of the many confusions surrounding "Asset Allocation"
is the idea that diversification and Asset Allocation are
one and the same. Diversification takes place within the
Asset Allocation divisions, or "buckets".
Next in line
would be the fallacy that Asset Allocation is a
sophisticated technique used to soften the bottom line
impact of movements in stock and bond prices. A
similar idea proposes that Asset Allocation is a process
that automatically (and foolishly) moves investment dollars
from a weakening asset classification to a stronger one, a
subtle "market timing" device.
Finally, there is the very widely
accepted myth that a properly designed Asset Allocation
formula must include a percentage of cash.
Asset Allocation is so much simpler than any of this!
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Still, because of it's "Buzz Word" status and general
acceptance as a valid investment concept, a warehouse full
of Asset Allocation models, programs, software products,
seminars, books, gurus, and worksheets have evolved.
The ultimate purpose of the Asset
Allocation tools is to sell investment products, various
types of analytical software (crystal balls), and an
assortment of speculative vehicles... that the providers
feel are "safe" to use in 5% increments.
And then there are the specialized
Asset Allocation computer programs that process your
personal data and propensities and then (after a few days so
that you'll think it is more than just boilerplate) spew out
a glossy "Personalized Asset Allocation Presentation" that
could have as many as 20 different decimal pointed
classifications and sub-classifications that your financial
advisor will be pleased to fill up with his favorite
investment products!
Proper Asset Allocation avoids all of this stuff, or it
certainly could!
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The basic Asset Allocation formula can
be a "kitchen table" plan outline, developed by crunching
very few numbers in tandem with a consideration of very few
"ball park" answers to some pretty basic, common sense,
questions. At retirement, for example:
- How much do you
have to invest?
- How much income
do you have from pensions, Social Security, etc?
- How much
additional income will you need?
Asset Allocation is not complicated
or mysterious, nor does the development of a workable Asset
Allocation formula require the (fee based) assistance of an
RIA, CPA, CFA, CFPC, or any other similarly designated sales
representative or fee based Asset Allocation Specialist.
I don't mean to diminish the
importance of having an experienced and skilled advisor to
help you with your Asset Allocation decisions. Just be
careful not to use someone who either has products to sell
or a referral fee arrangement with someone who does.
An Asset Allocation
Formula needs to be flexible, and flexibility is easier
to achieve with individual securities than it is with
products and contracts. Most advisors have a good working
knowledge of packaged products, and very little experience
with individual securities and their goal directed
management.
As thousands of
people have learned after reading
"The Brainwashing of the American Investor",
Asset
Allocation is so simple that anyone can do it!
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| The Asset Allocation
formula is the skeleton of the Investment Plan and, without
it, the investment process is directionless, disorganized,
and destined for failure. The Asset
Allocation process should divide the available investment
assets into two (and only two) classifications: Equity
Investments and Income Investments. Cash balances will, and
should, accrue but they must be reinvested appropriately.
After consideration
of such things as age, guaranteed retirement income from
outside sources, projected annual expenses, planned
retirement dates, and other goals and objectives, the
Income portion of the Asset Allocation formula is always
developed first. The remainder of the investment portfolio
becomes the Equity Asset Allocation.
Asset Allocation formulae must be simple
if they are to be manageable!
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Asset Allocation
considerations that you must be familiar with are these:
- any six figure
portfolio, at any age and regardless of any other
considerations, should have a Fixed Income component of
at least 30%, and
- all Asset
Allocation maintenance calculations absolutely must be
based on the cost basis of securities and not on their
current market values.
- Additionally, the cash and/or
Money Market Fund balances that inevitably appear in a
properly managed investment program must never be
thought of in non-Asset Allocation terms.
Every dollar (emergency cash
should be kept elsewhere) is being held temporarily
while you look for investments that belong among the
securities that are currently in the portfolio.
An Asset Allocation formulae with percentages that are
not evenly divisible by 5 (or which includes decimal points)
is a sales tool, and possibly the product of a sick computer
programmer! K. I. S. S.
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Investing is the process of
filling up the two Asset Allocation "buckets" with
securities, using a single investment strategy in a
disciplined and consistent manner. If you are
thinking of trying a strategy for a year to see if it works,
you've missed the point, and are confusing "strategy" with
"gimmick".
Running an Asset Allocation plan requires the use of a
strategy that can stand up to stock market and interest
cycles, with all of their wonderful fluctuations and
uncertainties. The strategy should
not be based on future prediction or on any promise of
unusually high rates of return, and the Asset Allocation
formula absolutely must not be tinkered with based on one's
perceptions of market conditions.
The Asset Allocation must be flexible (and the securities
liquid without penalty of any kind) so that gradual changes
can be made in response to changes in personal
circumstances. Absolutely never violate the Asset Allocation
Formula because of changing conditions in either the stock
or the fixed income markets.
The past twenty years or so have changed Investing from an
individual decision making process into a product shopping
mall... confusing, expensive, inflexible, and impractical.
You owe it to yourself to get some basic education before
you go there.
You'll find that you simply have to!
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In Investing, Quality is Job One in Any Asset Allocation
Formula.
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