Sunday 31 October 2010

Asset Allocation: Is it Necessary or Effective?

October 29th, 2009




 Asset allocation is a device used by investors and financial planners to populate a portfolio with an appropriate mix of investment vehicles selected from a smorgasbord of stocks, bonds, and occasionally other investments, each deemed to carry with it a uniquely predictable degree of risk.
Its goal is to optimize the return on the portfolio while taking into account  that investor’s tolerance for risk. And,  risk aversion is analyzed using such factors as the point the client has reached in her life cycle, her current and future responsibilities, her earning capacity—as well as the nuances of his or her character and personality.
The assumption is that there is an inverse relationship between  risk and return; and, the more aggressive the portfolio—one invested primarily in common stocks—the more risky it is.
Few amateur investors have the experience or know-how to apply asset allocation without the help of a professional. And, considering the view that most amateurs have of “investing,” the expense of such a professional might easily be justified. But….
I agree with Peter Lynch’s view that one should invest as if she were going to live forever. In my view, the most aggressive portfolio should be expected to generate no higher a return than the potential growth rate of a basket of well managed companies’ earnings—between 10% and 15% a year. And that there’s simply no need to dilute the return of a portfolio with any investment vehicles that would return less than that. I believe that’s all the “asset allocation” anyone needs!
The secret is to recognize that there is virtually no risk when you select those companies for their ability to grow their earnings consistently and adequately; and when you understand that the oscillations of the stock market—and the prices of the shares of the companies you own—have nothing whatever to do with the operation of those companies and the generation of profits for their owners. And, as an owner, you’re in it for those profits



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