A holistic view for achieving financial success: Asset Allocation
August 14, 2014
Successful investing has many components. Each plays an important role in contributing to your financial success.
Taking a holistic view of all variables is the preferred approach. We will cover this topic in two segments. Today’s article will review what should be considered when determining your portfolio’s asset allocation. Next week I will cover the various factors affecting your ultimate specific investment return.
Research proves that the most important investment decision you make is asset allocation, so this is a good starting point. Get that right and you are well on your way to success.
Any significant mistake in determining asset allocation makes it virtually impossible for you to achieve your desired investment outcome.
We strongly recommend you do not make any investment decisions until you have a written Investment Policy Statement clearly stating how investments should be allocated.
It is not possible to have an intelligent investment strategy before an investment portfolio’s construction is clearly defined. This is something within your control and to not have an Investment Policy Statement in our opinion is a serious mistake.
Asset allocation requires the decision to own stocks or bonds and determine the country or region from which these investments should originate.
The two considerations for choosing an asset allocation are risk and return. How much risk are you comfortable taking and how much risk do you need to take to achieve the target return on your investment? Taking risk will or should lead to a higher return.
Equities are stocks or shares of individual companies. In the short-term they may be risky. Stocks can change in value every trading day. During periods of stock market declines the value of stocks can and do decrease in value. Over time stocks as a category do well, but there is always a time when they do not perform well.
The variables that affect your equity investment return are the size of a company, its relative price defined as a stock being either a growth or value stock and finally profitability. Ultimately, these three factors will influence your returns whether you use this knowledge pro-actively or not.
Fixed income investments such as government or corporate bonds is the category that complements equities. Bonds are more consistent and, therefore, less risky. This can be an attractive investment; however, over a longer period bonds will deliver a lesser return than equities.
Fixed income or the bond investments will have a return based on two factors: term and credit rating of the bonds owned.
Term refers to the time when a bond matures and when you will receive your money back. Bonds with a lower credit rating are riskier. Those investments will need to offer a higher return to encourage investors to take that risk versus investing in a safer more conservative bond.
There is still a lot of guessing on how to invest and the financial sector does a poor job at advising investors about risk and return. Many decades of theoretical research clearly outline the dimensions of successful investing. Ignoring that research and decades of investment results shows disregard for what is known in favour of fiction.
Asset allocation is your most important decision to make. Your investment success will depend on those decisions.
Our recommendation is that you ensure you have carefully considered your portfolio’s asset allocation and that you make use of the available information to guide you to better investment returns.