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MAKING CENTS OUT OF THE NEWS
Blog #27
(July 22nd, 2010)
DIVERSIFY, BUT KEEP YOUR BALANCE
By Tom McAllister, CFP®
Asset allocation is often recommended by stockbrokers and financial planners alike, as a means of reducing risk in an investment portfolio. Since no one can accurately predict which assets will be the best performers at any future point, the idea behind asset allocation is to ensure that investors participate, at least in part, in the best performing assets during any particular cycle.
The following is an incomplete list of types of assets ranked according to the likely risks involved:
Cash (U.S. Treasury bills, money market funds, certificates of deposit)
Bonds (U.S. Governments, municipals, corporate, and “junk”, also divided into short-term, intermediate, long term in domestic, foreign, and emerging markets)
Stocks (domestic, foreign, emerging markets, also categorized by value or growth, and by large or small capitalization)
Real estate, including publicly traded Real Estate Investment Trusts)
Natural resources
Foreign currency
Precious metals
Collectibles (art, coins, stamps, etc)
Life insurance, including “life settlements.”
The potential for diversification is literally endless.
Diversify, diversify, diversify your investments, was the first lesson they taught us in Merrill Lynch training school in 1962. As I have written many times before, and as I emphasize in my lectures on cruise ships, diversification was - and is - wise and prudent and it does reduce the overall risk of any portfolio. I have no quarrel with asset allocation; with a mixture of asset classes, a portfolio is more likely to meet the investor’s wishes, goals and objectives in terms of balancing risk tolerance and possible returns. Diversification, described as “the only free lunch you will find in the investment game,” remains valid.
Where I disagree with many of my colleagues in the investment business is rebalancing. With the advent of Exchange Traded Funds, baskets of securities (or assets) which mirror a market index or a philosophy of investing, there has emerged a whole new breed of advisors who recommend rebalancing mathematically on a fixed time schedule. Selling my “winners” only to divert the cash into “losers,” following some sort of formula, has never made sense to me.
My own philosophy is to utilize, wherever possible, available cash from earnings of the portfolio and, if available, from additional contributions to the portfolio, to buttress the laggards. I also recommend that investors (and we investment advisors in our role as portfolio managers) “weed the garden” regularly. Money managers do this on an on-going basis. It is part of their job.
Individual investors should do so at least twice a year. Such efforts result in recognizing mistakes (Would I buy this position now under current circumstances?) and also determining when and where to take profits on our winners. Sometimes taking partial profits, such as 50% of the position, or perhaps enough to get back our original investment is a good idea. Cash proceeds from “weeding” are then available to add to lagging holdings.
Such an approach, especially when one uses a paid money manager, has been proven to reduce risk and to exceed normal expectations when using a “buy and hold” philosophy.
Diversify? By all means! However, don’t rebalance according to any formula. By judicious “Weeding” and “fertilizing” your holdings, you keep your balance!
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QUESTION OF THE WEEK:
Are there any asset classes you WISH (in hindsight) had been included in your portfolio? What is the best advice you NEVER took about asset allocation?
Click the link below to comment on this blog, or answer the blog question.
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