Without a doubt, asset allocation can be one of the toughest jobs for any private investor. On the one hand, it is quite theoretical in nature, but the impact on returns (both positive and negative) can be very real.
Asset allocation is essentially about the diversification of risk in an investment portfolio. For example, one holding on it's own offers a very high risk - if the company price falls, the entire 'portfolio' is impacted. The effect on personal wealth could be catastrophic.
In contrast, in a portfolio of ten holdings that are roughly equal in size, should one company fail or it's price plummet, only ten percent of the total portfolio is at risk. This seems much more sensible.
More than one
Quite an easy rule to remember would be that 'one is a lousy number in investment'.
As
an example, your author used to work with a Belgian man. His family was
'old-money' Belgian aristocracy and he had inherited a stake in Fortis,
a well known bank. His dividend income from that holding was around
€80,000 per year! That ought to give an idea of just how large the
holding was. A member of his family had been one of the founders of the
bank over 100 years previously.
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When the 2008 banking crisis hit, Fortis declared bankruptcy and his family wealth was wiped out in a matter of weeks. He had not even sold any of the holding to repay the mortgage on his family home. Very unfortunate.
More balance required
The mere fact that most of us own a residential property means that our investment weightings are heavily biased towards property and debt, so quite a large percentage of a person's net worth could easily be justified as being right to in equities and bonds.
Asset allocation is something that is very often overlooked - especially by less experienced investors. As a rule, if a new-ish investor asks about something, it will be, 'What stock should I buy?'. However, when talking to an experienced money manager, the topic of conversation will usually be about differing asset classes and diversification. The beginner can and should try to learn from this.
It is therefore vital that we all try and learn at least a little from the way a real fund manager operates and how he (or she) applies logical and profitable asset allocation methods.
Too much of a good thing
At the other end of the spectrum, a pension fund manager in charge of a 'general' fund will often have over 1,000 holdings in the portfolio. This will include government and corporate bonds, stocks and cash in a multitude of countries and currencies. This is the investment version of Noah's ark and 'two of everything'.
There is a happy medium in
between holding one asset and holding what appears to be one of
everything! My hope is that the following articles will enable you to
pick up some of these important ideas and that you will be able to apply
their principles to your own investment portfolio.
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As computing power multiplies and is used in ever more sophisticated ways, fund and money management theories are moving quickly and so it is important for the private investor to understand new thinking and methods of analysis.
If you are serious about investment, you need to be serious about this too. It is so important that the SEC has written this very useful beginners guide.
Each of the pages listed below was initially an article published in my free monthly email newsletter between 2006 and 2008.
Good luck with your own portfolio!
Asset Allocation And Portfolio Management For Individuals
Strategic Asset Allocation For Beginners
What Are The Two Main Fund Management Approaches?