Asset Allocation and Investment Selection

by Dual Income No Kids on July 27, 2009 · 0 comments

Hi All,

Okay, so following our recent theme of writing more about asset allocation, here are some thoughts about what kind of assets you want when you are building wealth.

1) Your portfolio should have a broad mix of assets. For example, you want different sorts of investments in your portfolio: bonds, stocks, real estate, commodities, cash, etc. etc. This is basic, everyone knows about diversification. That way if one of these investments tank, your overall wealth won’t take a devastating hit.

2) Okay, so that’s fine. Once you’ve decided on this the question is what are the characteristics of assets that should be held in your portfolio.

A) You want them to make money. That is, your assets should have long term healthy return. The end goal is to build your wealth.

B) High volatility. This is controversial, but if the overall fluctuation in price of your portfolio is steady, high volatility in an individual asset is okay. This allows you to implement buy low and sell high strategies and means that rebalancing has additional beneficial effects.

C) Negative correlation. Correlation is the degree of relatedness between two types of investments. Its important that your assets are not correlated with one another. For example, stocks and gold tend to be negatively correlated. This means, if your gold declines, then your stocks may increase.

Why is this important? For money. If your assets are negatively correlated your return tends to increase. At a minimum you’ll avoid being caught up in situations like last years big stock market losses.

3) Remember: A diversified portfolio should be diversified at two levels: between asset categories and within asset categories. So in addition to allocating your investments among stocks, bonds, cash equivalents and other investment types you’ll also need to spread out your investments within each asset type. So get gold and silver, large and small cap stocks and high yield CDs and savings bonds.

Best,

James

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