Asset Allocation Approach for Individual Investor

What Does Asset Allocation Mean?

An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

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There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of individual securities is secondary to the way you allocate your investment in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Asset-allocation mutual funds, also known as life-cycle, or target-date, funds, are an attempt to provide investors with portfolio structures that address an investor's age, risk appetite and investment objectives with an appropriate apportionment of asset classes. However, critics of this approach point out that arriving at a standardized solution for allocating portfolio assets is problematic because individual investors require individual solutions.
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Asset Allocation as Investment Tool

1. Asset Allocation is an Investment Planning Tool, not an Investment Strategy...few investment professionals understand the distinction, because most think that Investment Planning and Financial Planning are the same thing. Financial Planning is a broader concept, and one that involves such non-investment considerations as Wills and Estates, Insurance, Budgeting, Trusts, etc. Investment Planning takes place within the Trusts, Endowments, IRAs, and other Brokerage Accounts that come into existence as a result of, or without, Financial Planning.

2. Asset Allocation is a planning tool that allows the Investment Manager (you, if you haven't hired one) to structure the investment portfolio in a manner most likely to accomplish the goals of each specific investment portfolio AND of the investment program as a whole. Asset Allocation is the process of planning how an investment portfolio is to be divided between the two basic classes (and only these two classes) of investment securities: Equities and Fixed Income. Security sub-classes have little relevance.

3. Equities are the riskier of the two classes of securities, but not because of the price fluctuations that are their basic character trait. They are riskier because they represent ownership in a business enterprise that could fail. The risk of capital loss can be moderated or minimized in the security selection process and with a management control activity called diversification. The primary purpose for buying Equities is to sell them for capital gains, not to save them as trophies to brag about in chat rooms. They are less risky than other, non-fixed income endeavors. Fixed income securities are less risky because they represent debt of the issuing entity, and owners have a claim on the assets of the issuer that is superior to that of Equity holders and their salivating class action attorneys. With proper selection criteria and diversification, the risk of capital loss is negligible and price fluctuations can be ignored except for the trading opportunities that they provide. The primary purpose of these securities is income generation, either for current consumption or for use later in life.

4. An Asset Allocation Formula is a long-range, semi-permanent, planning decision that has absolutely nothing to do with market timing or hedging of any kind. It is designed to produce the combination of Capital Growth and Income that will achieve the long-range personal (pay those bills) goals of the individual. Thus, it must not be tinkered with because of expectations about anything, or rebalanced arbitrarily because of natural changes in the market values of one asset class or the other.

5. Asset Allocation is the only proven cure for inflation. If properly managed using 'The Working Capital Model', it will almost certainly increase the level of portfolio income by more than the rate of inflation, which is a measure of the purchasing power of your dollars, not the dollar value of your purchased securities.

6. In addition to the potential of failing to keep up with inflation using an Equity Only asset allocation, regardless of your age, greed management becomes much more of a problem. In a rising market, evidenced by more profit taking opportunities than lower priced bargains, investors tend to take positions in lower quality issues, current story stocks, newer issues, etc' just to be in there. A 30% or so Fixed Income allocation can be a major focus factor. How's that for throwing cold water on an ancient Wall Street maxim.

Sources and Additional Information:
http://www.investingvalue.com/investment-articles/authors/steve-selengut/asset-allocation.htm
http://www.investopedia.com/terms/a/assetallocation.asp
http://www.stockexchangesecrets.com/asset-allocation.html
http://stocks.about.com/od/buyingstocks/a/investsoftware.htm

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