How much do you know about asset allocation – the single most important aspect of investing? Read on. This Q&A was created by Jerry Miccolis, Principal and Chief Investment Officer at Brinton Eaton, a wealth management firm based in Madison, New Jersey, edited from the book he co-authored, Asset Allocation For Dummies® (Wiley 2009).
Q: What’s the best way to get consistently good investment performance?
A: It’s definitely not by being a good stock-picker nor is it by timing the market. The best, most reliable way to get consistently good investment performance is to determine an asset allocation mix that’s right for you—and stick to it. The performance of your investments will be determined mostly by your asset allocation. Your portfolio should include the fixed-income, equities and alternative asset classes. Deciding on a good asset allocation mix and adhering to it lacks the drama and excitement of chasing hot stock tips or trying to outsmart the market. But it’s likely to result in more money for you in the end.
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Q: How much variety should you include in your portfolio?
A: You may be tempted to stick with what you know. On the other hand, it may be alluring to pursue exotic investments that have been put together by some really smart people. Neither is a winning strategy. Your best bet is to stick with a mix of fixed-income, equities, and alternative investments (like real estate and commodities). If you limit yourself to what’s familiar to you, then your portfolio holdings will likely be concentrated in a couple of asset classes or subclasses. It’ll lack needed diversification. And exotic-sounding investments and strategies can have an even more disastrous effect on your portfolio. Many of these are very risky and carry very high fees.
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Q: What’s the best way to rebalance your portfolio?
A: Rebalancing — making trades when necessary to stick to your preferred asset allocation — can reduce your risk and increase your return over time. This is done by selling a piece of your winning assets and investing in your losing assets. At different times, some asset classes will go up or down faster than others. Whatever is hot will eventually cool off and whatever is cold will eventually heat up. Although it sounds totally counterintuitive, by selling when necessary to stick to your preferred asset allocation, you can keep a portfolio that stays warm all the time.
Q: When should you rebalance your portfolio?
A: Every day? Every quarter? Every year? No, no and no. You should rebalance when and only when your portfolio drifts significantly from your target allocation. If you rebalance too often, you’ll exit the winning assets too early, and the excess transactions costs from trading will eat away at your returns. If you wait too long, you may miss an opportunity to enhance your returns, as your winners become losers again. The best time to rebalance isn’t on a fixed, regular schedule, but when your portfolio gets significantly out of balance.
Q: What’s the riskiest kind of portfolio?
A: Paradoxically, it is often the one that unsophisticated investors would consider “safe,” such as very short-term bonds or certificates of deposit. The riskiest portfolio for you is one that has the lowest probability of meeting your overall long-term financial needs. Throughout your life, you’ll have numerous important goals, some of which are short term (such as funding education) and some of which are long term (such as living in retirement). Whatever financial goals you have, you want to make sure that your portfolio helps you meet those goals. To cover expenses that need to be paid soon, you’ll want to minimize volatility in your portfolio. For expenses that are farther into the future, you can take a longer view and tolerate the greater short-term volatility that comes with investing in assets that have higher expected returns.
Q: What’s better: An 8 percent return or a 9 percent return?
A: A portfolio with a simple average return of 9 percent is the clear winner, if both portfolios have similar levels of volatility. However, if the portfolio with the 9 percent simple average return is a lot more volatile than the one with the 8 percent simple average return, all that extra volatility will create significant erosion of your return over the long term—a phenomenon called “risk drag.” If the volatility and resultant risk drag are severe enough, it could cause the portfolio with the higher simple average return to leave you with less money!
Jerry Miccolis, CFA, CFP, FCAS, CERA, is Principal and Chief Investment Officer at Brinton Eaton. One of the country’s leading specialists in asset allocation, Mr. Miccolis also specializes in financial planning, risk management, investment research, and portfolio management. He can be reached at Miccolis@brintoneaton.com or 973-984-3352. For more information, read Asset Allocation For Dummies®, (Wiley 2009) for which this material was originally produced.
About Brinton Eaton:
Headquartered in Madison, New Jersey, Brinton Eaton has a long history of serving the wealth planning needs of individuals and families across multiple generations. The firm provides a full suite of wealth planning services, including lifetime cash flow projections, tax-reduction strategies and estate planning, investment management, charitable giving, business succession and retirement planning. Brinton Eaton maintains a strict focus on ensuring a client-centered philosophy and providing personalized wealth services to each and every client. Brinton Eaton is a member of the Mariner Wealth Advisors family of companies. Visit www.brintoneaton.com.
Disclosure
This document is for informational use only. Nothing in this publication is intended to constitute legal, tax, or investment advice. There is no guarantee that any claims made will come to pass. The information contained herein has been obtained from sources believed to be reliable, but Brinton Eaton does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.
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