Asset Allocation: Invest wisely to get your money's worth

Invest wisely to get your money’s worth

Comment     Mail to friend ET Bureau; Prashant Mahesh & Nikhil Walavalkar In the uncertain world of finance, we know that systematic investment and sticking to your asset allocation hold the key to success. But wealth management experts use asset allocation strategies not only to create wealth, but also to protect it during volatile times.  It is not the maximisation of returns, but optimisation of returns that becomes the goal of money managers. Asset allocation strategy has to be reviewed continuously.  This process plays a key role in determining the risk and return from your portfolio. Broadly speaking, the portfolio’s asset mix should reflect your risk taking capacities and goals. Wealth managers use different strategies of building asset allocations and we outline some of them and examine their basic management approaches.

Strategic Asset Allocation

Comment     Mail to friend Strategic allocation is typically the first stage in the investment process. Based on the investor’s long-term objectives, an initial portfolio is build. It is the backbone of any investment strategy. This often forms the basic framework of an investor’s portfolio. This is a proportional combination of assets based on expected rates of return for each asset class. For example, if stocks have historically given a return of 12% per year and bonds have returned 6% per year, a mix of 50% stocks and 50% bonds would be expected to return 9% per year. Strategic asset allocation generally implies a buy-and-hold strategy. “Strategic asset allocation defines the boundary of risk, and it is these boundaries that help control portfolio risk,” said AV Srikanth, executive director, Anand Rathi Wealth Managers.

Constant-Weighting Asset Allocation

Comment     Mail to friend Strategic asset allocation has its drawbacks as it entails a buy-and-hold strategy even if a change in the value of assets causes a drift from the initially established policy mix. This has driven the wealth managers to resort to the constant weighting asset allocation. This strategy helps you to continuously rebalance your portfolio. For example, if gold was declining in value, you would purchase more of it to maintain its weightage and if its value increased you would sell it. There are no hard-and-fast rules for the timing of portfolio rebalancing under strategic or constant-weighting asset allocation. Most wealth managers are of the opinion that the portfolio should be rebalanced to its original mix when any asset class moves more than 5-7% from its original value.

Tactical Asset Allocation

Comment     Mail to friend Over the long run, a strategic asset allocation strategy may seem relatively rigid. There are investors who constantly want to seek returns out of market opportunities that arise.  Hence, investment managers find it necessary to go in for short term tactical calls. Such tactical calls create room for capitalisng on unusual or exceptional investment opportunities. This is like timing the market to participate in the fluctuations and volatility that arise due to market conditions. “While a strategic asset allocation is revisited once in six months, tactical asset allocations are visited every month,” said Hrishikesh Parandekar, CEO, Karvy Private Wealth. Tactical calls are on an ongoing basis. For example, shifting a part of the portfolio from large cap stocks to mid cap stocks to take advantage of the environment is a tactical call.  “We restrict our tactical calls around 10% of the total portfolio and rest of the money is strictly governed by strategic allocation,” said a wealth advisor with a foreign wealth manager. Tactical allocations being opportunistic in nature, wealth managers prefer to maintain clear time-based and value-based entry and exit points to ensure better risk management.

Guided and optimised allocation

Comment     Mail to friend This can be seen as the advanced version of tactical asset allocation. When tactical asset allocation aims to take advantage of temporary situations in the market, the concept of guided and optimised allocation believes in squeezing the last drop out at all times. By very nature, it is meant for a bit aggressive investor. Here 75% of the clients’ portfolio could follow the original asset allocation, while 25% of the portfolio will explore opportunities where there could be chances of making higher return. So, investing in gold futures for a quick buck, or short-term corporate deposits offering higher rate of interest and such other opportunities remains on investors’ lookout. Here you must continuously stay tuned with the financial markets. The strategy further demands you to take into account transaction costs as the investors turn hyper active in search of higher returns

Dynamic Asset Allocation

Comment     Mail to friend For aggressive investors who want to ride momentum at times, managers recommend dynamic asset allocation. So, if the stock market is showing weakness, you sell anticipating a further fall. If it is going up, you buy anticipating a further rise.  Here you constantly adjust the mix of assets as markets rise and fall. This is the opposite of constant-weighting strategy. As the entire portfolio is available for action, amateur investors may turn hyper active. Especially in the high volatile times, acting on all types of information can lead to high transaction costs. Also, the tax treatment of the returns turns to disadvantages if you churn your portfolio too much. In times of high volatility, when the markets may not move up or down much, dynamic asset allocation is not advisable for naैंve investors. Depending on the type of investor you are, asset allocation could be active or passive. However investors should choose one keeping in mind their age, long term goals and risk taking capacity in mind.

http://economictimes.indiatimes.com/quickiearticleshow/5951589.cms

Wealth Maximising Strategies for your Portfolio

Buy only GREAT (good quality) stock.

Buy at a bargain price, when the upside reward/downside risk ratio is highest. Be patient.

Sell the losers.  Stay with the winners.

Sell the losers early.  Reinvest into GREAT stocks.

Sell the under-performers early.  Reinvest into GREAT stocks.

# Sell the overpriced stocks to lock in the 'transient bubbling' gains (PE > 1.5x Signature PE).  Reinvest into GREAT stocks.

Reinvest and Stay with the GREAT winners for the long term.

Stay concentrated.  Do not overdiversify. Invest big.

? Tactical Asset Allocation when the market is OBVIOUSLY too expensive or too cheap.  (Difficult strategy to apply consistently).


# Warren Buffett's investment in PetroChina



Also read:

Growing at 15% a year - what does this entail?

Asset Allocation and Economic Hedging in Various Economic Environment

Asset Allocation

This is also referred to as economic hedging and can be defined as a conservative method of diversifying assets so they will react different under various economic conditions.

Successful investing can be based on 4 key characteristics as follows:

• Discipline
• Patience
• Historical Prospective
• Common Sense Strategy

Reasons for using asset allocation:

• History repeats itself
• No one can predict the future – not even the experts
• Comfort in knowing you have not painted yourself in a corner
• Acts as a hedge against financial risks you cannot control

To protect against risks, the risks must first be identified and then investments set up to diversify around them. Listed below are the main types of economic environments.

• Hyper Inflation (100%+/year)
• Double Digit Inflation (10%+/year)
• High Inflation (5 to 9%/year)
• Normal Inflation (2 to 4%/year)
• Recession
• Depression

Now lets look at a couple examples of how various investment types do in these differing environments.

In a depression we see the following:

• Stocks go way down (85-90%)
• Real Estate – Also tends to go down
• Interest Rates – drops to very low rates
• Unemployment – this goes way up
• Property – material things tend to lose value
• Bonds – These do well, as bonds tend to vary inversely with interest rates.

Recommended investment in a depressed economy then would be high quality, intermediate term (2-4 year), discounted corporate bonds.

On the other hand in a Hyper-Inflation economy the situation would be completely different.

• Stocks – do well for a while, then collapse
• Real Estate – depends, because it is often bought with debt
• Gold – this has done well in keeping its value in hyper-inflation conditions

Of note, the last time the US was in a hyper-inflation economy was during the civil war. However several other countries have been in this situation in recent years.

Now that we know how the environment can affect different investments, let's look at what investments are best for each environment and how to protect your investments in these changing economic times with economic hedging.

http://www.nassbee.com/wealthy/asset_allocation.html

Economic Hedging

Following our discussion on asset allocation, below is a list of the best types of investments for each type of environment.

Economic Environment	Best Investment
Hyper Inflation	Gold
Double Digit Inflation	Real Estate
High Inflation	Real Estate / Stocks
Normal Inflation	Stocks
Recession	Cash
Depression	High Quality Corporate Bonds

How you will allocate your assets will depend on if you are in or near retirement as well as other personal circumstances. Below are two basic allocation structures. You should review your own needs to decide what type of allocation meets your needs best.

Aggressive

Cash	Bonds	REIT	Stocks	Gold
15-20%	15-20%	30%	30%	2-5%

Retired

Cash	Bonds	REIT	Stocks
25%	25%	25%	25%

(These percentages can be vaired slightly to fit in 2% Gold for better hedging.)

Over the past 30 years, average yields for these types of investments has been about as follows:

Investment	Avg Yield
Cash	4%
Bonds	7%
REIT	8%
Stocks	10%

For the retired plan then this would have yielded a safe 7.25% annual return. For the aggressive investor it would closer to 8%.

Rebalance

In order to keep the advantage of asset allocation you should rebalance your investments every year. When this is done is not important as long as it is done at least once per year. By taking profits from the investment types that are doing well and putting the money in those that are down, you are buying low and selling high without any emotional input that may cloud your decision. Rebalancing should then be done as follows:

• Periodically (at least once per year)
• If there is a major change in your life
• If there is a major change in the financial market

http://www.nassbee.com/wealthy/economic_hedging.html

Allocate funds wisely, enjoy your golden years

26 Mar 2010, 0427 hrs IST, Lovaii Navlakhi,


Let us take the case study of a 65-year old and analyse the same. Mrs X has Rs 50 lakh and has invested the same in different products. Each of these has different time horizons and varying rates of return; some are taxable and some are tax-free. Mrs X requires Rs 25,000 pm to manage her lifestyle. 

Regular Cash Flow 

At this moment, she may be quite relaxed as her investments are earning more than her required earnings of Rs 25,000 per month. There could be some issues in terms of regularity of the income, as some of the interest payouts are not monthly. Returns from mutual funds may not be regular too, but in this case is a buffer.

Asset Allocation 

The portfolio of Rs 50 lakh has just 12% of the assets in equity, and hence, is a conservative portfolio considering Mrs X’s age. Since this seems sufficient to meet her goals, we are fine with her investment in fixed income instruments to the extent of 88%. There is, of course, a possibility that Mrs X has a running PPF account in which she can deposit the returns from her equity MFs and continue to earn 8% tax-free returns. As one is aware, the maximum that one can add in a PPF account in a financial year is Rs 70,000.

Taxable Income 

The returns from equity MFs by way of dividends are tax free. The income subject to tax amounts to Rs 3,42,500 for the year. However, Mrs X can take benefit of the Rs 1 lakh invested in ELSS under Section 80C (even investment in PPF can get the same benefit, subject to a maximum of Rs 1 lakh at present), and thus have a taxable income of Rs 2,42,500. Since Rs 2,40,000 of income is exempt for senior citizens, Mrs X will pay a tax on only Rs 2,500 @ 10%. Thus, her returns of 8.3% on her portfolio are virtually tax-free.

Liquidity Analysis 

We assume that Mrs X will live to the age of 90 years, and hence she needs this money to last her for the next 25 years. Prima facie, earning a return of Rs 3 lakh per annum does not seem difficult. However, we have not considered the rate of inflation — if it is 6.5% p.a, the funds will last her 20 years. Further, in case she needs Rs 5 lakh as medical emergency, the money will run out in 18 years. An alternative suggestion to Mrs X will be to increase her equity allocation to 25%, and push her portfolio returns to 9% p.a. That way, her funds last her for 25 years, if inflation remains at 5% p.a.

A financial planner will evaluate the portfolio from multiple perspectives such as returns, risks, liquidity, taxability and even longevity; and approaching one could give you peace of mind, and a greater piece of the action on earth. Get one today!

The author is the MD & Chief Financial Planner of International Money Matters Pvt Ltd. 


http://economictimes.indiatimes.com/articleshow/5725337.cms

The buy-and-hold strategy

The buy-and-hold strategy

Jonathan Chevreau, Financial Post Published: Friday, April 17, 2009

Among the many casualties of the great bear market of 2008-09 may be the buy-and-hold strategy or the Warren Buffett approach of buying good businesses and waiting patiently for the market's perception of their value to catch up.

Indeed, when it seemed the market had hit new lows last November, CNBC aired a feature declaring the "death of buy-and-hold," with pundits claiming only suckers hung on through thick and thin. And value-oriented fund company AIC Limited, which still uses the slogan "buy, hold and prosper," has suffered from such derogatory variants as "buy, hold and perspire" or "buy and fold."

But rumours of the death of buy-and-hold may be premature.

The Investment Reporter, a well-regarded newsletter founded in 1941, recently concluded buy-and-hold portfolios do better over the long and short run, citing an academic study (by Lakonishok, Schleifer and Vishny) that looked at returns of actively managed pension funds over six years. It found that, on average, buy-and-hold portfolios beat actively managed portfolios by 0.78% a year, not factoring in taxes, management fees or high cash positions.

A buy-and-hold approach

• minimizes commissions and tax events and, naturally, 
• lowers the chances of mistiming the market. 

It's compatible with passive indexing strategies, but you don't have to be an indexer to benefit from this approach. It can be used equally with quality dividend-paying stocks, ladders of bonds or GICs.
Dan Richards, president of Strategic Imperatives, says investors have swung from buy-and-hold to frequent trading but either extreme is a "prescription for disaster." He says academic research from Terrence Odean and Brad Barber shows frequent trading hurts investment returns. The two American business professors wrote a seminal article in 1999 called Online Investors: Do the slow die first?

Vancouver financial advisor Clay Gillespie believes buy-and-hold works for various forms of managed money, such as mutual funds, wrap accounts and other fee-based investment management solutions, although it may not always work with stocks. "An individual company may go out of business and thus have a return of zero." With a particular stock, it may be necessary to sell when

• there are changes in one's personal situation, retirement, for example, and
• it's advisable to reduce volatility. 
• Portfolio rebalancing may also require some tweaks in the buy-and-hold approach. 

But "style drift" usually tends to produce poor performance over time, he says.
Mutual fund companies encourage buy-and-hold, often levying short-term trading penalties on those who trade in and out too often. Typically, fund unitholders buy high and sell low when they switch too often. "It is this multi-percentage point drag that buy-and-hold investors are trying to avoid," says Norm Rothery, chief investment strategist for Dan Hallett & Associates.

Joe Canavan, chairman of Assante Wealth Management, believes fund investors can successfully build portfolios that include both fund managers who use a buy-and-hold approach as well as managers who use a frequent-trading approach. The danger is in trying to do only one or the other, then changing your horses midstream.

That is more likely to result in being "whipsawed," Mr. Canavan says, incurring losses with one strategy, then abandoning that for the opposite approach just as the tide was about to turn.

In his Canadian Capitalist blog, Ottawa-based Ram Balakrishnan advises to "keep faith in buy-and-hold." He reassures readers it's "hard to maintain equanimity in the face of such a steep decline as right now. But what other strategy is there other than buy-and-hold, where almost everyone can have a good shot at reasonable returns? I don't think there is one."

Unlike most advisors, Robert Cable, Toronto-based head of ScotiaMcLeod's Cable Group, is a strong believer in "seasonal" market timing, also called a "sell in May and go away" strategy. While investors may want to emulate Warren Buffett and buy and hold forever, in practice "nobody does it," he says. He recalls asking 300 advisors at a Florida conference how many of their clients had bought and held the same portfolio a decade or more. The only hand that went up represented a client who was literally in a coma following an accident and whose account could not be traded.

"Anyone who goes into investing with the intent of buying and holding virtually always succumbs to outside pressures to abandon the strategy. My guess is when we have nobody believing in buy-and-hold again, we will again be ready for one big bull market to take off," says Mr. Cable.

Markham-based advisor Robert Smith says buy-and-hold works, but not in isolation. Investors need

• proper asset allocation geared to their risk tolerance, 
• portfolios must be well-diversified and 
• investments can't have been purchased at bubble-like prices. 
• They also need to buy during the tough times to bring down their average costs, he says.

"If the investor follows all these requirements, buy-and-hold will not fail them," Mr. Smith says.

Read more: http://www.financialpost.com/story.html?id=1507182#ixzz0eYEmvC9K
The Financial Post is now on Facebook. Join our fan community today.

http://www.financialpost.com/story.html?id=1507182




Comment:  My personal experience of 20 years, buy and hold is safe for selected stocks. 

The New Year's No. 1 Investing Tip

The New Year's No. 1 Investing Tip
By Tim Hanson
December 31, 2009

Take a close look at your portfolio and your asset allocation to make sure that it matches your expectations for the next year and beyond. If it doesn't -- and this is the most important part -- then make sure you take the time to rebalance.

What I'm about to tell you could be the most important investing tip you get this year -- even better than if I gave you the name of some race-car growth stock that might double in 2010. But for you to appreciate its importance, I need to tell you two true stories.

True story No. 1
2007 had been a flat year for the market, but we started getting signs at the end of the year that all was not well with the housing market. The S&P took a sharp 10% dive from October to December and newspapers were reporting more and more about a looming "subprime" crisis. Yes, Ben Bernanke cut interest rates, but by the end of 2007, though the scale of the eventual crisis was not yet clear, it was obvious that there were at least a few weak links in the financial sector.

It was at this time that I took a look at my portfolio and realized that I was more than 25% weighted in the financial sector stocks such as Berkshire Hathaway (NYSE: BRK-A), optionsXpress (Nasdaq: OXPS), and International Assets Holding (Nasdaq: IAAC).

Before you call me daft, let me explain how such a thing could happen. First, financial sector stocks were coming out of a period of healthy growth, and my holdings had grown in size from their original positions. Second, financial stocks generally look like attractive buys because of their asset-light business models and high returns on capital. And third, I hadn't paid attention to my overweighting in real-time because these companies weren't operating in the same parts of the financial sector.

Yet overweight position across financials scared me when I saw it at the end of 2007 since my outlook for financials in 2008 wasn't all that rosy.

What happened? I rebalanced my portfolio by selling some of my financial stocks and saved myself a lot of pain as a result.

True story No. 2
Fast-forward to the end of 2008. The entire stock market had dropped nearly 50% and stocks with higher risk profiles -- such emerging markets names -- were down even more than that.

As a consequence, when I looked at my portfolio, I realized I now had less than 10% of my money invested in emerging markets even though I believed countries such as China, India, and Brazil were going to lead the world into recovery in 2009. After all, these countries were still posting positive GDP growth and had attributes -- such as a higher savings rate in China, a younger population in India, and a wealth of natural resources in Brazil -- that seemed like they could better help them survive and perhaps even thrive through the downturn.

So what did I do? I rebalanced my portfolio by selling some U.S. stocks and buying more shares of promising emerging markets names such as America Movil (NYSE: AMX), Mercadolibre (Nasdaq: MELI), China Fire & Security (Nasdaq: CFSG), and Yongye International (Nasdaq: YONG).

As you can see from the returns below, my emerging markets thesis played out as expected and my decision to buy more of those stocks helped make my returns dramatically better than they would have been otherwise.

Stock
2009 Return

America Movil
55%

Mercadolibre
217%

China Fire & Security
103%

Yongye International
425%


The New Year's No. 1 investing tip
Now that you know those two true stories, I hope you can appreciate the importance of taking time at the end of each calendar year to take a close look at your portfolio and your asset allocation to make sure that it matches your expectations for the next year and beyond.

If it doesn't -- and this is the most important part -- then make sure you take the time to rebalance. Not only could rebalancing save you a lot of pain (as it did me in 2008), but it can also help you make a lot more money (as it did me in 2009).

http://www.fool.com/investing/international/2009/12/31/the-new-years-no-1-investing-tip.aspx

Asset Allocation Basics

Asset allocation is the spreading of assets among different categories of investments, typically among stocks, bonds and cash. It provides protection against drastic market volatility and the corresponding fluctuations. When you allocate your assets you should have in mind different factors, the most important one being your risk tolerance.

Often believed to be one of the most important factors that may influence your chances of success in stock investing, many experts advise asset allocation to be practiced with the greatest caution.

When applying asset allocation you should concentrate on combining stocks, bonds and cash in different proportions. The process of asset allocation is the selection of the percentage by which each investment category will be present in your portfolio.


http://www.stock-market-investors.com/stock-investing-basics/asset-allocation-basics.html

Assets to invest in.

Here are some assets to invest in.

1.  A residence.
This is often the first property acquired.  Choose a great property to make a good home.

2.  A premise for own business.
With so many commercial buildings available, renting is also an option.   Location and suitability to the business are important.

3.  Commercial property(ies) for rental income.
Location. Location. Location.  But be prepared for the problems of being a landlord.  Capital appreciation the last 10 years and rental income have been poor in those locations where the supplies exceed demands for rental properties.

4.  Land for residential, industrial or commercial use.
Needs a large initial capital.  No income or minimal income yield for many years until the full potential of the land is realised.  However, capital appreciations over many years are often huge.

5.  Plantations for income.
For those with the enthusiasm to manage an oil palm plantation, this is still a great investment.  Equally, acquiring stocks of plantation counters serve the same purpose.

6.  Cash in FDs or fixed income investment products.
Worth keeping some cash for emergency use.  However, the buying power of cash is eroded by inflation over many years.

7.  Shares in the local bourse.
Probably the better investments for those with the necessary financial education.  But be prepared for the market price fluctuations (volatilites).  Take advantage of market volatility and make it your friend.  Do not fall folly to it.

8.  Shares in the overseas bourses.
This is part of diversifying your assets overseas.

9.  Own business.
A challenge for those who has the zeal of an enterpreneur.  Higher risk but the rewards can be hugely substantial.

10.  Buying whole or part of new businesses.
For those with the enterpreneur spirit.  But be prepared to manage the business.

A sideways pyramid to increase your Retirement Income.

Increase Your Retirement Income

by Mary Beth Franklin
Monday, November 2, 2009

This new money-for-life strategy creates both guaranteed income and growth potential.

In the midst of the stock-market meltdown in October 2008, Arthur Szu-tu, a relatively new retiree at 60, was gripped with fear and anxiety. He had no pension, he was too young to collect Social Security benefits, and he was relying completely on his savings. "Intellectually, I knew I couldn't cash out my stocks because I might live another 35 years and I would need the higher investment returns that come from stocks," says Szu-tu, a former technology manager from Syracuse, N.Y. "But emotionally, it was really scary."

As retirees watched their account balances plummet, many were advised to reduce their withdrawals or go back to work to preserve their nest eggs. "The thought of becoming a Wal-Mart greeter or McDonald's counter boy did not allow me to sleep at night," quips Szu-tu. He decided that he would rest easier if he mentally separated his investments into two groups: cash and bonds that could sustain him through his initial years of retirement, and stock funds that he would leave untouched until they could recover and grow.

Without realizing it, Szu-tu had stumbled on an alternative income model that has been kicking around in some retirement-planning sectors for more than 20 years but attracted little attention until recently. As long as the stock market was booming -- and bonds performed well when stocks tanked -- the so-called 4% rule for systematically withdrawing retirement income from an investment portfolio worked well.

That rule of thumb became the gold standard for creating sustainable retirement income. According to the 4% rule, if you invest in a moderately risky portfolio of 60% stocks and 40% bonds, you can initially withdraw 4% of your assets, increase that amount in subsequent years to keep pace with inflation, and still have a 90% probability of not running out of money over a 30-year retirement.

Probabilities are fine -- until you become a statistic. The recent bear market was so severe and so unusual (because virtually every asset class, except Treasury bonds, suffered severe losses) that it has called into question even that conservative strategy. The biggest threat to retirement wealth is withdrawing too much money from a shrinking nest egg, because there may not be enough left to benefit from the inevitable market rebound. Retirees were urged to skip their annual inflation adjustments -- or, in cases of severe investment losses, to reset their 4% distribution schedule based on their new, lower balance.

"If it weren't for inflation, cash and bonds would be all you need," says Lubinski. But even with modest inflation of 3% a year, your buying power would be cut in half in about 25 years, so you need to invest for future growth, too. When you add stocks to your portfolio, however, you also add risk.

In retirement, "clients are more concerned about reliability of income than about return on investment," says Lubinski. "You can't chase both at the same time." But you can achieve both goals if you compartmentalize your money based on short-term, medium-term and long-term needs.


A sideways pyramid.

Jim Coleman, head of Coleman Financial Advisory Group(http://www.colemanadvisorygroup.com/), in Waterbury, Conn., has added his own twist to the income-for-life model. When describing the strategy to clients, he tells them to think of a classic risk pyramid, which puts the safest investments (such as bank accounts and money-market funds) at the bottom and layers progressively riskier investments (such as bonds and stock funds) building to a peak.

In the classic model, even if your investments are diversified, all your assets are at risk at the same time. Coleman flipped the pyramid on its side so that you tap the most conservative, risk-free investments at the beginning of your retirement timeline and let the riskier investments grow until the later years. Your most aggressive assets will have years -- and possibly even decades -- to grow, creating a source of stable retirement income in the future. "With this divide-and-conquer strategy, you can have the best of both worlds," says Coleman.



KipTip: A New Angle on the Risk Pyramid

This alternative model for retirement withdrawals delivers current income and future returns.

With a traditional risk-pyramid model, you use your safest investments -- such as bank accounts and certificates of deposit -- to build the foundation of your portfolio. Then you layer riskier investments on top, adding bonds, followed by various types of stock funds and alternative investments that might include commodities and real estate. Diversification spreads your risk, but it doesn't guarantee that you won't lose money.

By flipping the risk pyramid on its side, you can align your retirement timeline with your investment strategy. Fund your immediate income needs with risk-free investments, such as CDs or an immediate annuity, and gradually increase the risk (and potential return) of other investments. Every five years, use investment returns to replenish your guaranteed income.

http://finance.yahoo.com/focus-retirement/article/108055/increase-your-retirement-income;_ylt=ArlNO.c7ri6qIIasaoxRuVu7YWsA;_ylu=X3oDMTE1azc1c250BHBvcwMyBHNlYwNmaWRlbGl0eUZQBHNsawNpbmNvbWVmb3JsaWY-?mod=fidelity-readytoretire

Did you profit from the best stock rally in the last 10 years?

More specifically, how much of your investment money was in equity in March 2009?  One prominent blogger by his admission was 30% or so anxiously invested in first half of this year.  But salutation and hooray to those with 80% or more invested in stocks in March 2009.  :-)

Has the stock market rise disturbed your portfolio?

Has the stock market rise disturbed your portfolio?


Consider this, suppose the prices of potato, ghee and sugar dropped to half, would you double your consumption and reduce that of the other food stuffs? Unlikely! You eat a balanced diet and a sudden price change does not make you change your diet drastically. Why then, should you behave differently with your money life and increase the proportion of an asset just because its price has taken its value higher? Rebalancing is a smart way to keep the portfolio suited to your risk and return needs.

Every portfolio has a mix of different instruments - debt, equity and cash. Debt, or interest-bearing instruments like bonds, income mutual funds and deposits, give low risk moderate returns, equity, or shares and stock market mutual funds, is risky and can give higher returns. Cash is the emergency and opportunity fund that gives very low returns, but is liquid and safe. Ideally, as a person ages, he should reduce the equity part of his portfolio and increase the lower risk debt since the risk-taking capacity goes down with age.

At each age and stage in life, each person will have his own unique asset allocation that works for his risk and return needs. For example, a 38 year old person may have an asset allocation of 60 per cent in equity and 40 per cent in debt and a 60 year old could have 20 per cent in equity and 80 per cent in debt. The idea is to stay at the chosen asset allocation at a particular age, even if the markets keep changing. Therefore the need for rebalancing.

Rebalancing the portfolio means coming back to the original asset allocation at least once a year, as markets take the value of the portfolio up or down. Consider this: in April 2003, a 38 year old with a 60:40 asset allocation in equity and debt has Rs 10 lakh in his portfolio. This means he has Rs 6 lakh worth of shares and equity mutual funds and Rs 4 lakh worth of debt paper like bank fixed deposits, debentures, bonds and funds. Now, almost a year later, the rising stock market has taken the collected value of his equity portfolio to Rs 12 lakh - his State Bank shares rose sharply, the index funds went up and so on, but his debt did not gain since interest rates did not fall and there was no capital gain on his bond funds. Now his asset allocation is Rs 12 lakh: Rs 4 lakh or 75:25 without him making any fresh investments or changing any older investments simply because the market took the equity value of his portfolio higher.

But this person had been comfortable with a 60:40 asset allocation, should he be at 75:25? No, he should go back to his original asset allocation, if he feels he cannot expose his portfolio to this higher level of risk. He can do two things:

Sell a part of his equity holdings to book profit and buy debt. It is difficult to sell the winner to buy the loser, specially when it looks as if the markets will keep rising. But remember, that if you don't rebalance, the market may do it for you and you will lose the profit you could have booked. Don't sell your entire holding of a favourite stock, sell a part of it and use the money to buy into debt instruments.

Make all fresh investments in debt. This may be difficult as such a large amount of money may not be available to bring the asset allocation back to the original level. It also prevents the person from booking profit, but it is an option for a person reluctant to sell in a rising market and yet needing to rebalance.

Booking profit to come back to your original equity-debt split is a smart strategy as it allows you to enjoy the gains and yet keep the desired proportion between assets intact. Remember to check on the tax angle before you sell. Sometimes it may be better wait a couple of months to become eligible for the lower long term capital gains tax. Sometimes it may be good to sell some stocks that have lost along with some winners to offset the losses to the gains.

How often should you rebalance?

Rebalance your portfolio once a year. Do it around tax investment time as your focus is already on money matters. Rebalance in the interim, if you feel that one asset class has suddenly shot up alarmingly. For example, the stock market vroom since April 2003 should be making you re-look at your portfolio now. But don't micromanage and churn for every percentage change in the asset allocation. A sustained 10 to 15 per cent change is the trigger to rebalance.

Is there some way to automatically rebalance?

If you find the job of managing your portfolio too heavy and rebalancing is a word you don't even want to hold, look at mutual funds. The newly launched fund of funds category is the most efficient way to follow the rebalancing strategy. A fund of fund invests in other mutual fund schemes. Fund houses like Birla Sun Life Mutual Fund and Prudential ICICI are offering different asset allocations to suit investment needs that will automatically rebalance according to the chosen asset allocation.

When should you not rebalance?

If you feel that your risk profile has changed and you can take higher risk, you can let your portfolio run on and not book profits. This is a high risk strategy, be aware of the risk and then do it, if it suits your profile.

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How best to allocate your funds?

To a certain extent, that depends on your risk appetite, which in turn hinges on your individual circumstances.

A risk-averse investor may hold more cash, and a risk-tolerant investor vice-versa.

Allocation will also depend on market conditions.

Equity risk premium can be a good guiding principle for asset allocation decisions, i.e., when to hold cash and when to hold stocks if you are looking at just 2 asset classes.

Even if you have high tolerance for risks, it would be foolish to allocate 80% of your portfolio to equities during a stockmarket bubble.

And even, if the market was "normal" when you allocated your assets, prices will move, leaving you holding more of one asset class than you desire. In which case, you might want to rebalance your portfolio.

Stocks, bonds or cash? How much you hold of each asset class - or asset allocation - is the most important decision in an investment process. Studies have shown that about 95% of variations in returns on portfolios are explained by asset allocation decisions. Only about 5% are due to other causes, such as security selection.

Ref: Show Me the Money by Teh Hooi Ling

Asset Allocation is not the same as Diversification

Asset allocation is not the same as diversification.

Rather, it refers to the strategy of allocating your investment funds among different types of investments, such as stocks, bonds, or money-market funds.

• In the long run, you will be better off with all of your assets concentrated in common stocks.
• In the short run, this may not be true, since the market occasionally has a sinking spell.
• A severe one, such as that of 2000-2002, can cause your holdings to decline in value 20% or more.
• To protect against this, most investors spread their money around.

They may for instance,

• allocate 50% to stocks, 40% to bonds, and 10% to a money-market fund, or,
• a more realistic breakdown might be 70% in stocks, 25% in bonds, and 5% in a money-market fund.
  
  
  

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A Simple Approach to Asset Allocation
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A Simple Approach to Asset Allocation

Serious investors spend a lot of time deciding which stocks or mutual funds to buy. This is appropriate. If you are going to invest your money, you shouldn't do it without some research and thought.

On the other hand, some financial gurus maintain that it is far more important to make an effort to achieve an effective approach to asset allocation. They believe that you should place your emphasis on how much of your portfolio is invested in such sectors as:

Government bonds
Corporate bonds
Municipal bonds
Convertible bonds
Preferred bonds
Large-cap domestic stocks
Small-cap domestic stocks
Foreign stocks
Foreign bonds
Certificates of deposit
Annuities
Money-market funds

There are probably a few other categories you could include in your portfolio, and examining this list gives you an idea of what is meant by asset allocation.

The importance of asset allocation is in understanding how it can help or hurt you during certain investment periods.


A Simple Approach to Asset Allocation

From the above, you can see that asset allocation, like everything else in the world of finance, can get rather complex and confusing. It is no wonder that many people don't delve into this too much.

Here is one such approach by an investor.

"My idea of investing is to make it simple. There are just so many hours in the day. If you are still gainfully employed, you probably work eight hours in the day making a living. In the evenings, you may spend a few hours a week reading journals and other material so that you don't get fired. Obviously, that doesn't leave much time for studying the stock market.

For my part, I don't invest in many small-cap stocks, foreign stocks, bonds, convertibles, preferred stocks, or most of the other stuff on this list. I prefer to invest mostly in big-cap stocks (such as ExxonMobil, GE, Merck, IBM, Procter & Gamble, and Johnson & Johnson) and money-market funds (a safe alternative to cash).

This reduces my categories to two (2), not a dozen. All you have to do is decide what percentage of your portfolio is in stocks. The rest is in the money-market fund. Of course, the percentage is vitally important."



Related posts:Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Forget about Everything Else and Buy Only Stocks

Believe it or not, there are some investors who are convinced that common stocks - and common stocks alone - are the royal road to riches.

"A good friend of mine has never bought anything but stocks, and he's been doing it for many years. He even went through the severe bear market of 1973 - 1974, when stocks plunged over 40 percent. He wasn't exactly happy to see his stocks being ground to a pulp, but he hung on. Today, he is a millionaire many times over. He's now 60 years old, still a comparatively young investor. His name is David A. Seidenfeld, a businessman in Cleveland."

David Seidenfeld got his start by listening to the late S. Allen Nathanson, a savvy investor who wrote a series of magazine articles on why common stocks are the best way to achieve great wealth. David Seidenfeld recently collected these essays and published them as a hardcover book, Bullishly Speaking.

If you start investing early, such as in your forties, this method can work. If you systematically invest, setting aside 10 or 15 percent of your earnings each year and doing it through thick and thin, you won't need any bonds, money-market funds, or any of the other alternatives that financial magazines seem to think you must have. You will arrive at retirement with a large portfolio that will enable you to live off the dividends.

However, if you arrived late to the investment party - let's say in your late 50s or early 60s - you may not be able to sleep too well if you rely entirely on common stocks. After all, stocks have their shortcomings, too. They tend to bounce around a lot, and they can cut their dividends when things turn bleak.


Read also:

The story of Uncle Chua
Uncle Chua's Portfolio & Dividend Income

and

Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Some asset allocation options to consider

For the ultraconservative investor, a suggestion is for you to invest only 55% of your portfolio in common stocks. To be sure, when the stock market is marching ahead, as it has in the 90s, you won't be able to keep pace. But if it falters and heads south for a year or two, like recently, your cautious approach will keep you out of the clutches of insomnia.

Generally, such an approach is considered timid, and is not the best way to approach asset allocation. However, many are using this formula and are not complaining.

A better way to handle the uncertainty is to invest 70% in stocks, with the rest in a money-market fund. Once you decide on a particular percentage, stick with it. Don't change it every time someone makes a market forecast.

These market forecasts don't work often enough to pay any attention to them. No professional investor has a consistent record in forecasting. Every once in a while, one of these pundits makes a correct call at a crucial turning point, and from that day on, every one listens intently to the pronouncements of this person - until the day the pronouncement is totally wrong. That day always come.



Related posts:Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
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Some asset allocation options to consider
A favourite Formula for Asset Allocation

How Much Should You Invest in Stocks?

When it comes to deciding on the percentage you should devote to common stocks, there are several alternatives that should be considered. All have some merit, and none are perfect.

In fact, there is no such thing as a perfect formula for asset allocation.

It depends on such factors as

• your age, and
• your temperament.

It might also depend on what you think the market is going to do.

• If it's about to soar, you would want to be fully invested.
• But if you think stocks are poised to fall off the cliff, you might prefer to seek the safety of a money-market fund.

Related posts: Some Simple Formulas for Asset Allocation

• How Much Should You Invest in Stocks?
• Asset Allocation is not the same as Diversification
• A Simple Approach to Asset Allocation
• Forget about Everything Else and Buy Only Stocks
• Some asset allocation options to consider
• A favourite Formula for Asset Allocation

A favourite Formula for Asset Allocation

Age is the key to asset allocation. The older you are, the less you should have in common stocks.

If you are age 65, you should have 65% in common stocks, with the rest in a money-market fund.

If you are younger than 65, add 1% per year to your common stock sector. As an example, if you are 60 years old, you will have 70% in stocks.

If you are older than 65, deduct 1% a year. Thus, if you are age 70, you will have only 60% in stock.

Here is a table breaking down the 2 percentages by age:

Age--Stocks--Money-Market Funds

40---90%---10%
45---85%---15%
50---80%---20%
55---75%---25%
60---70%---30%
65---65%---35%
70---60%---40%
75---55%---45%
80---50%---50%
85---45%---55%


Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

With success, bank some profits

If the fundamentals continue to look good and are supported by a favourable price trend, do not take profits.

However, if you are doing particularly well, you should cut winning positions to keep a balance in your portfolio and take cash out of the market.

There have been some very high-profile billionaires who have gone completely bust. They probably took a lot of risks to get there, which were too bold for most people. Why didn't they just put a lazy hundred million on the side, in case it all went horribly wrong?

Here is a sensible way to lock-in some wins.

Value all of your positions on the basis of the current market price. This process ignores your original entry price, and any other price along the way, such as a high or a low.

If your investments are going really well, you may find that their mark-to-market value significantly exceeds the original risk amount you had in mind.

As an example, say you, allocated 20% of your assets to trading, and the positions have done so well that on a mark-to-market basis, they are now worth 40% of your total assets. Here you should probably reduce your positions and bank some profits. This would even be regardless of supportive fundamentals and a trend in your favour.

Over the years there were times when an investor or trader reduced positions which were doing well and which looked good going forward. Those decisions had nothing to do with their views on their fundamentals, but were simply to take cash out of the market.

Five Things To Know About Asset Allocation

Five Things To Know About Asset Allocation
by Investopedia Staff, (Investopedia.com)

With literally thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. However, starting to build a portfolio with stock picking might be the wrong approach. Instead, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold - this is referred to as your asset allocation.


What is Asset Allocation?

Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives.

Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a settlement for mediocrity, but for most investors it's the best protection against major loss should things ever go amiss in one investment class or sub-class. 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 stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual - if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation:

Risk vs. Return

The risk-return tradeoff is at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer.

The crashes of 1929, 1981, 1987, and the more recent declines of 2000-2002 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc.

What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. (To learn more about bond investing, see Bond Basics Tutorial.

Don't Rely Solely on Financial Software or Planner Sheets

Financial planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan.

For example, one rule of thumb that many advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stock and the remaining 35% into bonds, real estate and cash.

But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them.

Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.

Determine your Long and Short-Term Goals

We all have our goals. Whether you aspire to own a yacht or vacation home, to pay for your child's education, or simply to save up for a new car, you should consider it in your asset allocation plan. All of these goals need to be considered when determining the right mix.

For example, if you're planning to own a retirement condo on the beach in 20 years, you need not worry about short-term fluctuations in the stock market. But if you have a child who will be entering college in five to six years, you may need to tilt your asset allocation to safer fixed-income investments.

Time is your Best Friend

The U.S. Department of Labor has said that for every 10 years you delay saving for retirement (or some other long-term goal), you will have to save three times as much each month to catch up.

Having time not only allows you to take advantage of compounding and the time value of money, it also means you can put more of your portfolio into higher risk/return investments, namely stocks. A bad couple of years in the stock market will likely show up as nothing more than an insignificant blip 30 years from now.

Just Do It!

Once you've determined the right mix of stocks, bonds and other investments, it's time to implement it.

The first step is to find out how your current portfolio breaks down. It's fairly straightforward to see the percentage of assets in stocks vs. bonds, but don't forget to categorize what type of stocks you own (small, mid, or large cap).

You should also categorize your bonds according to their maturity (short, mid, long-term). Mutual funds can be more problematic. Fund names don't always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested.

There is no one standardized solution for allocating your assets. Individual investors require individual solutions.

Furthermore, if a long-term horizon is something you don't have, don't worry. It's never too late to get started.

It's also never too late to give your existing portfolio a face-lift: asset allocation is not a one-time event, it's a life-long process of progression and fine-tuning.

by Investopedia Staff, (Contact Author Biography)

Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.

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