What’s the right asset allocation?
Public Domain. Source: Wikipedia
In simple terms, asset allocation is the process of deciding where to invest your money. Not who to have manage it – like Vanguard or an advisor – but what to have your money invested in: stocks, bonds, real estate, bank deposits, commodities. Your asset depends on a couple of basic questions: what do you need the money for, when will you need it, what other resources you have, and other specific issues, like your tax situation, your access to the funds, and so on.
Also, it matters where things stand in the market right now. Stocks have been on a run, but not all stocks. The FANG stocks – Facebook, Amazon, Netflix, and Google – are up 35% so far this year, far outpacing the averages. It’s hard to see what might get in their way. But what goes around comes around. In the late ‘90s the “Four Horsemen of the Internet” – Cisco, Sun, Oracle, and EMC – were all the rage. And then the worm turned, and only one of those stocks ever got back to its record high.
Asset allocation seeks to smooth out these booms and busts by putting some money in US stocks, some in foreign stocks, some in bonds, and some in cash. The challenge comes from the fact that stocks contribute most of the return to a portfolio, but also contribute most the risk. A 50/50 stock/bond portfolio will still be mostly correlated with stock market returns. It just won’t have as much risk. The bond allocation will act like a sea-anchor to the portfolio: slowing it down when times are good, and holding it up when the market contracts. It may be galling to see stocks rise in the double-digits while bonds seem to go nowhere, but those bonds felt pretty good during the Financial Crisis.
Source: ReSolve Asset Management
The right asset allocation is what’s right for you: your circumstances, your preferences, your opportunities. Don’t get sucked into the latest hot trend. We don’t know the future. Chances are, today’s darling could be tomorrow’s dog.
Douglas R. Tengdin, CFA