How to Design an Asset Allocation Strategy

The Financial Planning profession generally regards asset allocation as the most reliable method to generate investment returns with a minimum of risk. The universe of potential investments is made up of a variety of investment types or styles that all differ in their performance over time. By spreading one's investments over these various styles, investors can reduce volatility and maximize their portfolio's performance. We won't get into the mathematical proof of the validity of this claim, but let us refer you to Rational Investing in Irrational Times, by Larry Swedroe, for a complete discourse on the topic.

The various types of investments include, but are not limited to, the following: stocks or mutual funds classified as large-cap, mid-cap, small-cap, growth, value, blend, sector, foreign, or emerging markets, various types of bonds and interest-bearing securities, real estate, collectibles, and cash. By analyzing your particular risk tolerance, investment horizon, long-term goals, and expectations, you can determine which combination of these investments is right for your portfolio.

This is a fairly complex and time-consuming process. If you are married, you should work on this process together, even if one or both of you is inexperienced in these matters. A good financial planner will help you to define common ground and find the strategy that works for both of you. If you haven't gone through this process, we can guarantee you that you are not invested correct allocation for you. The chance of a proper asset allocation happening by accident is almost non-existent. Here are two sample allocations we prepared recently for clients with differing requirements:

Young, Moderately Aggressive (Client A) Middle Aged, Moderately Conservative (Client B)
Investment Real Estate 30%
Cash / Money Market 10% 20%
Large Cap Growth Funds 15% 20%
Large Cap Value Funds 15% 20%
Small Cap Growth Funds 10% 10%
Small Cap Value Funds 10% 10%
International Funds 10%
Investment Grade Bonds 20%
Total 100% 100%

Once you have determined your strategy, you implement the plan by acquiring the appropriate assets, and then monitoring the portfolio at least annually. Two important things change each year:

One of the difficulties encountered by investors is the vast array of information that comes their way. You will hear about stocks in the grocery line, the locker room, at the water cooler, on TV and radio, and in printed media. It is difficult to filter through all this information and find the truth. Most of what you hear is anecdotal evidence at best and wishful thinking at the worst. We refer to this dribble as "investment pornography." Anyone who promises that they know which way an individual stock or mutual fund is going in the short term is misleading themselves and their audience. Successful investing is a game of percentages - choosing the right mix of investments to produce the highest probability of achieving the outcome you desire.

So, as you can see, there is no ultimate asset allocation strategy. Investors must tailor their own strategy according to their needs. If you are looking to us for investment advice, we must first go through the analysis before we can help you pick stocks or real estate investments. We won't be able to guarantee that your portfolio will make you a millionaire, but we will be able to guarantee that you will get the best possible portfolio to achieve your objectives.

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