Perhaps it's only human, but when the
investment
markets teeter, people want to do
something. This fear
of the unknown has given rise to
elaborate timing
techniques promoted as the panacea for
market
volatility.
This reactivity may ease one's nerves,
but history
reveals a dismal track record for
market timing. It is
doomed to fail because it ignores
these truths:
1.
Reactive investing is always a day late.
2.
Asset groups behave cyclically.
3.
There's more safety in diversity.
Asset allocation, a relatively new
investment
approach gaining favor among
institutional investors
and professional money managers, has
proven its
superiority to timing and prediction. More recently,
individuals have started implementing
it in their own
portfolios.
It involves diversifying assets among
several
investment groups in order to maximize
returns while
minimizing risk. It is the only scientific strategy
that blends portfolio diversification,
long-term trends
and the specific level of risk you
want to assume into
a personalized investment plan.
Risk and return
Asset allocation starts with your
needs as
identified in your financial goals and
anticipated
money requirements through each major
stage of your
life.
The risk level you are willing to assume is
integral to forming this plan, and the
principles of
risk and return guide your
decisions. Remember that in
the risk-reward spectrum, there is no
free lunch. A
higher targeted return means assuming
a higher level of
uncertainty.
You achieve an "efficient"
portfolio by striking
an optimal mix between return and
risk. In other
words, you try to meet your goals
without assuming more
risk than necessary. Different combinations of
investments will produce varying
degrees of risk and
overall return.
Asset groups do not behave the same
way at the
same time, and asset allocation
diversifies money
across a broad spectrum of investment
groups to
capitalize on this countercyclical
behavior. It
incorporates performance histories
into computer
programs to develop a portfolio
compatible with your
risk-return profile. The resulting plan should tell
you how much money to invest in each
asset category and
the likelihood of achieving the stated
investment goal.
A new perspective
Asset allocation takes portfolio
diversification
to a new level of sophistication. It is designed to do
more than simply spread risk. It also takes into
account the synergy achieved over time
by efficiently
mixing assets in weighted amounts.
And what does all this do for
you? For one, it
changes your investment
perspective. When stocks fall,
oil prices drop, or gold skyrockets,
you don't feel the
urge to do something. (In fact, you may not do
anything at all.) Because your asset allocation model
has already accounted for this
volatility, you don't
worry about it.
This disciplined, systematic approach
to investing
protects you from impulsiveness while
providing enough
flexibility to capitalize on
opportunities unveiled
throughout the cycle. While other investors are
purging their portfolios based on
yesterday's events,
you are fine-tuning yours in
anticipation of future
trends.
Asset allocation is probably the most
personal
investment approach because it takes
shape from your
attitudes regarding risk and
wealth. Furthermore, it
changes with your changing needs. As you move through
different financial stages of life,
you adjust the
portfolio accordingly.
A solution for the '90s?
Some analysts frequently speak of
"the uncertain
financial markets of the '90s" as
if past decades were
full of certainty. Where was the "certainty" in World
War II, Korea, the Cuban Missile
Crisis or the Arab Oil
Embargo?
Only the past is in clear view. Asset allocation
relies on the notion that long-term
trends are more
easily recognized than short-term
fluctuations. A
mountain of information is available
to plot the
behavior of stocks, bonds,
international securities,
precious metals, oil and gas, real
estate and other
major asset groups in varying economic
conditions. A
financial advisor can use it to apply
allocation
strategies to your portfolio. Mutual funds can also
play a vital role in this process, as
you can combine
them to achieve the desired
effect. There are even
asset allocation funds.
Asset allocation provides a balanced,
rational
approach to building long-term
wealth. If implemented
with discipline, it can bring order to
a permanently
uncertain investment environment.
In the next chapter we talk about mutual
funds,
and about an asset allocation service
that uses mutual
funds as part of its program.
No comments:
Post a Comment