Deciding Your Asset Allocation
Asset allocation is the most important decision you will make as regards your investments because over 95% of the returns you will earn on your investments over your lifetime depend on this one single decision. Put simply, what you need to decide is what portion of your investment money you put in stocks or stock-related investments and what portion you put in bonds or bond-related investments. In other words, how you divide up your money for investment. As in life, many of the most important decisions can be made very simply. An easy formula is to put 100 minus your age in percent in stocks and stock-related investments. For instance, if you are 25 years old, you would put 100-25 or 75% of your investment money in stocks and stock-related investments and the balance in bonds and bond-related investments. While this cookie-cutter approach has been criticised, it is still a very good guide to asset allocation. Another approach would be to have 60% in stocks and 40% in bonds. This captures about 90% of the returns of stocks but reduces the volatility of your portfolio by half. More complex asset allocation models are discussed below. Why: Asset allocation allows you to enjoy the benefits of all the asset classes you invest in. The two major and traditional asset classes are stocks and bonds. If you divide up your money between stocks and bonds, you benefit by getting a higher return on your investment in the long run from the stock portion of your investment, but you also reduce the volatility that comes with stock investments by having a steady return from bonds. What to invest in: You need to decide what asset classes you wish to invest in. Here are some:
1. Systematic Investment Plan (SIP) - You will need a few hours once or twice a year.Setting up a Systematic Investing Plan for investing in mutual funds is a one time exercise. Most mutual funds will arrange a direct debit to your savings account or alternatively you can write post dated checks. In a falling market, an SIP will allow you to limit your losses. In a rising market, your profits will also be limited, but that is the trade-off you have to live with for convenience. You will need to track your investment whether in stock or in mutual funds which is why you need to set aside some time every few months. For mutual fund investments, you will need to sell investments which have underperformed in the last 2 quarters. For stocks you will need to evaluate whether you should remain invested in each stock. If setting aside time is a problem, consider investing in index based Exchange Traded Funds (ETFs). 2. Value Averaging - Set aside a few hours every few months.Value Averaging is aligning your portfolio to a projected value - for instance, if your projected portfolio value one month down the line is 1% higher than now, your 100,000 portfolio would be worth 101,000. But if you assets have only increased to 100,400 you would invest the shortfall of $600 to make up the value to 101,000. If you have $1000 to invest every month, you would invest the remaining $400 in a liquid fund, to make up future shortfalls. You would do this for each portion of your portfolio, equity and debt, so that the debt:equity ratio is maintained. On the other hand, if your assets have gone up to say 102,000 you would then withdraw $1,000 and park this excess return in an easily accessible form, a liquid or money-market investment so that this amount is available to you for emergencies, or for future investment. For more on these buffer investments please visit the link below.3. 'Automatic' Investing as popularised by Lichello - Lichello's Automatic Investing requires some calculations, but does help to invest when the market is down and withdraw when the market is up. But it has no rules written in stone. If you have to tweak a system to give you better results than SIP or VA, you could end up tweaking all you want but you cannot predict how markets will behave in the future. All your tweaking will fit the system to perform the best for the last five or ten years of past data, but as the disclaimer goes, past performance is no guarantee of future performance. That said, markets do move in cycles and you may be able to eke out a few percentage points of improvement at least some of the time, with Automatic Investing. For an overview of Automatic Investing Basics, check out this link. Buffer Investments Return From Asset Allocation to Creating-A-Life-Plan.com Home Page |
