"She Got Mixed Up With the Wrong Crowd...it All Went Downhill From There."

Understanding The Importance of Asset Allocation

By Anthony Rhodes

Let's take a trip down memory lane. Recall, if you would, those wondrous high school years in which we first began the important task of learning to categorize various groups together. There was, for example the jocks; who, depending on how good you were at sporting activities, may or may not conjure favorable thoughts on the subject, the cool kids; who may have been the envy of the school and the desired association of most, and the nerds; who probably had more than their fair share of being picked on by others during these awkward periods of their lives. Now, in each of these instances, we speak of classifications; all of whom were students, but who were also distinctively different from one another. Your association within one group may have taken you down this particular path, and being with others may have led you down yet another .

The wisdom to know the difference is what this post is all about.

The knowledge generated from the ability to identify and organize is very important, but when you attach it with an understanding of where such data leads to, it becomes paramount. This truth is the basis of our discussion for this week. Learning how to allocate your investment assets is THE most important component of a successful portfolio. So, with that in mind, we'll seek to understand that while consumers are familiar with the famous real estate slogan of "Location, Location, Location", investors ought to become familiar with the equally true investment mantra of "Allocation, Allocation, Allocation".

The In Crowd

The first step down the road to understanding asset allocation is to become familiar with the various sectors which make up our economy. Each of these sectors represent specific objectives; such as Growth, Defensive and Income. For example, utilities generally pay out relatively high dividends to their shareholders, and therefore occupy the Income portion of the spectrum. Small cap stocks are known for their potential to grow rapidly, and are therefore categorized under the Growth objective. And consumer staples are known for their ability to produce revenue, regardless of the state of the economy, and are therefore placed within the Defensive objective. Once you have a complete understanding of your overall investment goals, it then becomes easier to select which sectors are appropriate for you. But always remember that your objectives may change from time to time, and that when this takes place, so too should your allocation.

Risky Business

Asset allocation exists to help manage risk. But, as with any other tool, if not used properly, it loses its effectiveness. For this reason, it's very important to be honest about your financial state when constructing your allocation. Avoid the temptation to be more aggressive than your means will allow, by placing only the amount within that portion of your portfolio that you can afford to lose (unless you are an aggressive investor). Typical investors generally place the bulk of their monies within investments which are deemed safer, such as blue chip stocks and fixed income instruments (i.e. bonds). To round out the portfolio's diversity, and to complete the allocation process, the remainder of such a portfolio might be spread amongst other diverse items, such as international securities, commodities or various currencies. However, once completed, your portfolio should represent the entirety of your investment goals, and when conjoined with your time horizon, should set you on the path to overall investment success.

The importance of asset allocation can't be overstated. When performed correctly, it can be the basis for a successful portfolio, and when not, can prove to be its downfall. This is why investors need to spend an appropriate amount of time learning how to master its implementation. Taking out the time to evaluate your financial picture, and to determine your goals and objectives, may harken one back to those bygone years of homework, pop quizzes, and standardized tests. But now, just as then, your association within the right or wrong group, will ultimately determine whether you wind up passing or failing. 

(Anthony Rhodes  is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective www.theplanningperspective.com )