Proper asset allocation ensures successful portfolio performance

May 1, 2005

Keep in mind that there are plenty of successful investors who never own more than a half dozen investments at one time, some even fewer.

However, while the year is still young, this is also a good time to take a look at the other side of your financial life - what you're doing with all that money you're making in your practice. As I've mentioned before, you don't want to be among those practitioners who do a great job charting their course through difficult business waters, while neglecting the even trickier sea of personal finance.

Asset allocation There is general agreement among personal financial advisors that asset allocation is one of the most important keys to successful investing.

In short, asset allocation is how your money is divided up among investments in stocks, bonds, cash and cash equivalents . . . and how it's divvied up among the various choices within each of those categories. Sounds complicated, but it really isn't.

For example, if you have 60 percent of your portfolio invested in mutual funds devoted to stocks, you may choose from among funds that specialize in large, medium or small companies. Within those funds, you may choose from such categories as fast-growing small companies, old-line blue chip companies, high dividend paying companies, and on and on. There are mutual funds to satisfy almost any investment objective - hundreds and hundreds of them. While choosing a handful from among that assortment may seem a bit overwhelming, it's a lot easier than trying to pick individual stocks from among the thousands and thousands on the market.

In trying to do a good job of asset allocation, some investors wind up with small investments in each of dozens of mutual funds. Not a good idea. That approach isn't likely to improve your overall results, and keeping track of a basketful of different investments could turn out to be a discouraging task.

Keep in mind that there are plenty of successful investors who never own more than a half dozen investments at one time, some even fewer.

Best allocation So, what is the best asset allocation for you?

That depends on several important variables. At the top of that list is your timeline. The longer you have before retirement the larger should be the portion of your portfolio invested in stocks. That's because historical averages show that stocks provide the best return of any class of investments over a long period. Thus, if you have lots of years before you must start drawing down your investments, you have time to ride out the invariable dips in the market that cause stocks to fall in price temporarily.

A study recently published by Ibbotson Associates, a highly regarded market data firm (http:// http://www.ibbotson.com/), clearly shows the long-term advantage of stock investments.

From 1926 through 2004, the 500 largest companies (as represented in the S&P 500 index) returned an average of 10.4 percent per year. Small company stocks did even better with an average return of 12.7 percent per year. During the same period, long-term government bonds (maturities in 10 to 30 years) returned 5.5 percent.

The lowest return of all during the period was from investments in cash or cash equivalents such as savings accounts, CDs, or money market accounts. These averaged 3.7 percent per year.

Related Content:

News