The Advantages of Asset Allocation

Includes: DIA, SPY
by: Andy Abraham

Asset Allocation simply means distributing your money across various investment avenues in order that the poor performance of any one avenue or asset does not jeopardize the entire investment plan and yearly return. Asset allocation is one of the basic premises of having an investment plan. As basic an idea, it is one of the rarest traits in a financial plan. Would you even consider getting on a plane without a flight plan and the pilot not knowing where he is going? It is an obvious answer. Many times I have encountered investors that feel that they are well diversed. They feel that they fulfilled the premise of asset allocation with stocks, bonds, cash and a little real estate. They would own some large cap or blue chips, some mid caps, small caps and a sprinkling of some international shares or funds.

However, when you diversify across assets you give yourself a lot of leeway to counter market uncertainties. When the stock market is progressing well, one probably cannot appreciate the importance of asset allocation. In fact, you may even feel that asset allocation is a hindrance when having all money in equities seems to be a smarter way to ride the stock market rally. It usually takes an adversity (such as a sharp fall in stock markets) to fully appreciate that having more than just stocks and bonds in your portfolio can be a big bonus. The advantage of having different assets in the portfolio is that a decline in any one asset can be partially offset with the presence of other assets. Many times different assets react differently to the same set of factors.

This brings me to my plan on how to expand one's asset allocation.

In many inflationary periods - such as now - Managed Futures have excelled and propelled a portfolio. All one has to do is look at the price of oil. How much has it gone up? What about gold?

How much of an allocation one should you own is a little tricky, because it will vary from investor to investor and each's risk profile. Depending on the exact plan such as money management, corelation and risk per trade, different levels of volatility can be experienced. In inflationary times, commodities trend upwards and in deflationary times, commodity prices fall and trend downwards. I am not a proponent of one trading these vehicles themselves but rather in a managed account or fund. The volatility and leverage can be great. At a minimum, one should consider managed futures for at least 5% of the portfolio.

These are very uncertain times, and one owes oneself to be aware that you need to think outside the box, and look to assist in protecting one's investment portfolios.