Buzzword No 2: Asset Allocation
May 15, 2007Thanks for visiting! If you like what you're reading, you may want to subscribe to my RSS feed.
Along with diversification, asset allocation is probably one of the topics that gets an investor talking for a looong time. In simple terms, asset allocation is the brains behind diversification in that it examines how to diversify your portfolio to get the best (overall) return given your attitude to risk. It is based on modern portfolio theory and certainly seems to require a lot of Maths to come up with the following, relatively simple graph:
Even though I do find this quite interesting, none of the mathematical background is required to find a diversification method that suits your needs. In fact, there is no such thing as an ideal way of arranging your portfolio, because it all depends on your individual circumstances, your goals and your age. While young, you can stomach a high percentage of stocks because you have plenty of time to sit out a dip in the market, while someone who has 3 years left till retirement should really opt for a safer portfolio with a higher percentage of bonds…
You can find plenty of sample portfolios on the web (and in books…) which are adjusted towards different risk attitudes. Especially if you don’t have much experience, these models are a good way of starting out and can be adjusted over time as you learn and gain more familiarity with the different options available.
Generally, investors can be classified as conservative, moderately conservative, defensive, balanced, moderately aggressive and aggressive with the proportion of stocks (vs. bonds) increasing as you go along. There is no test to determine which group you belong to, but it is something you need to find out for yourself. Read here to get a brief overview of each category together with a sample portfolio (which may or may not work for you, but should give you a reasonably good idea of the proportions involved).
I have been shopping around a little myself and the portfolio that looks most attractive to me is taken from the book “All about Asset Allocation” by Richard Ferri. So far I’ve only read a summary online, but I’m contemplating to get the book myself - not only to read more about the model portfolio but also to extend my knowledge of the different asset classes.
More about Ferri’s portfolio for young investors soon…
