Once you’ve gotten your debts paid off with your short term cash parked safely in a certificate of deposit or two and in high interest savings accounts, you may be finally accumulating hard-earned moneys that will be better applied elsewhere and are wondering what to do with the savings you have growing steadily with nowhere to go as yet. What to do? Well, if you’ve finally taken some time to reflect on your goals and life situation, done some research and gotten some questions answered; if you are set to get your feet wet in more rewarding money growth opportunities with the resources you have at the ready, then it’s time to asset allocate!
Well what is it exactly?
Other than being one of the more popular topics among personal finance blogs, asset allocation is the process by which an investor divides up and earmarks their money for various purposes and investments to achieve a well suited portfolio matched up to the investor’s requirements, lifestyle, goals and timeframe. Distributing your money across different asset classes based on your financial profile will yield your asset allocation, so the idea is to match the profile to the appropriate plan.
There are many asset allocation methods ranging from creating a plan for each goal you may have, all the way to just maintaining one for your current stage in life. So depending on how you’d like to do it, you may have many portfolios across different financial institutions, each geared toward a different goal such as your child’s education, a new house or retirement; or maybe if you’d like to keep with a “Keep It Simple and Sweet” theme like I do, then you’d only have one overriding plan that aligns with your age, life circumstances and investor profile.
I personally prefer to wrap up my savings and assets into one neat allocation scheme that will address my financial situation and future requirements, then keep tabs on that. What is great about performing this strategy is that it takes some of the mystery out of investing by allowing you to once more put things in automatic. If you find a portfolio type that you agree with, then your goal would simply be to ensure that your assets align with this configuration as closely as possible. Every 6 months to a year, you can check your allocation to see if it’s still as you expect and if things have changed since, you can rebalance it. I found this to be a great tool for enforcing some semblance of order and discipline to my investments, once more taking some emotion out of it! One more way you can sleep at night even if the market decides to go ballistic.
Asset Allocation Plans
Here is a table for matching up investor profiles with sample allocation plans. Note that allocations themselves (percentages allotted to various classes) may vary and are based on decisions you can make and are comfortable with. Many financial institutions such as Scottrade, T.Rowe Price and Fidelity offer suggested portfolios which are worth a look. Investment resources like Morningstar are also great places to start.
| Investor Profile | Recommended Portfolio | Portfolio Description |
|---|---|---|
| Conservative | Stability | This is best for short term goals, where you will need the money in the next few years. Since stocks and bonds have some volatility and can fluctuate over time, it is best to keep your funds in stable vehicles such as such as money market securities, CDs, bank accounts and shorter-term bonds. |
| Moderately Conservative | Income | For lower risk, go for bond and money market investments. This strategy may allow for a bit of a kick, mild though it may be; however returns may still be lukewarm and outpacing inflation is not certain. However, this may be appropriate for short to intermediate term goals, folks who shun volatility or those close to retirement. |
| Defensive | Moderate Income | Still somewhat conservative, this portfolio has devoted 20% to stocks and real estate, with the bulk still in bonds and cash. This combination is intended to avoid excessive volatility but has the potential to earn returns that at least keep pace with the rate of inflation. |
| Balanced | Balanced | With 50% allocated to higher risk investments such as stocks and real estate, this approach aims for more growth but with reasonable risk. This approach can be appropriate for retirement as well as nonretirement investors with mid- to long-term goals. |
| Moderately Aggressive | Growth and Income | With the bulk of this portfolio in stocks, you are definitely aiming for higher returns and have a stomach to ride some swings in the market. This portfolio is great for younger people and the more aggressive investor who is willing to assume relatively high risk for potentially greater returns. You will need a longer time frame to ride things out so that you don’t get tempted to bail out during changes in market conditions. |
| Aggressive | Growth | This is for investors with a lot of guts and ability to withstand temporary losses during market cycles. It has the potential to provide the highest returns relative to all other portfolios, but can surely make you squirm when things aren’t going north. The younger you are, the better this sort of portfolio is, however I recall that no matter how young I was, I never had the disposition for this type of portfolio — again it’s a matter of knowing yourself well enough to see if you have the nerves for this type of mix. |
Asset Classes
Some of the more common asset classes that comprise an allocation are:
- Money Market and Short Term Bonds, which comprise cash, checking, savings accounts, term deposits and less than one year investment grade bonds.
- Bonds, which cover investment grade bonds.
- Domestic Equities, which are stocks listed on your local market.
- International Equities covers stocks listed in or related to a foreign country.
- Real Estate / REITs includes your real estate (your main residence excluded) and stocks related to property.
Sample Portfolios
I have attempted to put together some sample allocations using the various aforementioned asset classes.
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| Stability: Conservative | Income: Moderately Conservative | Moderate Income: Defensive |
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| Balanced: Balanced | Growth and Income: Moderately Aggressive | Growth: Aggressive |
Other possible asset classes can include among others, stocks and bonds in emerging markets, gold, commodities, currencies, penny stocks or options, but these are usually found in more sophisticated, esoteric and potentially more aggressive portfolios.
What next?
Now even with setting aside these rather more challenging topics, there’s still more stuff to tackle with regards to deciding how to partition your money across the classes. For instance, with bonds, there are all sorts of bonds and bond funds to select. And with stocks, it’s easy to get confused about whether you should get into individual stocks, ETFs, mutual funds, or whether you should go for value versus growth, small versus large caps….. Ahhhh! It can all be quite much to take in one sitting. That’s something I’ll surely be tackling at another time.
In the meantime, you can bask in the knowledge that you are on your way to making your money work for you and with a better idea of where you stand as an investor, you’ll be able to identify what kind of portfolio will jive best with you. As for me, I’m a moderately aggressive investor. And how does my real portfolio stack up to the “target mix” displayed above? That’s one more thing I need to check out to see if I will have to do some rebalancing, so stay tuned for the sequel.
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