20 Oct The Little Known Secrets of Asset Allocation
Asset allocation correctly formulated with an investors risk profile is considered the key to any successful long term investment
The influence of emotional bias on investment decisions can be detrimental to a portfolios long term outlook. What we are saying is that if you let your emotions determine your investment decisions then this can work against you in the long run. Lets start with one particular problem, holding too much of a particular asset, whether it be cash, shares or property. The obvious
issue here is that you are opening yourself up to falls or risks in one particular asset class. If this asset class, say property or shares , has debt against it then this is further increases the risk of the associated asset. We then need to consider the investors stage in their work life. Are they working? If they are, how stable is their employment or industry? If they are self employed what risks do the face? This then leads into the area of adequate personal insurances which I shall not cover off on in this article but is extremely important.
It is also important to consider such things as income requirements. If you are early in your working life then income from investments is less of a consideration usually. As you start to head towards retirement this will change and your portfolio needs to be adjusted accordingly. We usually find that 5-7 years out from retirement you need to adjust your asset allocation or should be considering where additional money is directed in your portfolio. This then leads into diversification, spreading the risk across a number of sectors.
In recent years dynamic asset allocation (DAA) has become favourable
This works in conjunction when determining the best asset allocation, DAA is the process of making adjustments to a portfolio when assets become over-valued. This is where there is a clear sign that an asset is overvalued and should possibly be sold or reviewed. Fund managers in share portfolios do this and it is advisable with direct share portfolios to do the same. An example may be something like this, resource shares become overvalued but financials may be undervalued, a switch is made accordingly over a period of time and a transition is made from one asset class to the next.
One of the most important lessons with asset allocation is to ensure that the underlying assets are safe. A portfolio of Australian blue chips that make up all 200 shares in the ASX200 with dividends reinvested since 1950 had earned over 10% per year as at the end of 2013. This is the equivalent of turning $100 in to $153,000 over that period of time.