3/1/98
Probably the most important investment decision investors can make is determining their asset allocation. Asset allocations is the mixture of stocks, bonds, CDs, money market funds and real estate that one has in their investment portfolio.
What is an Investment Asset?
I tend toward the theory that your house is not an investment though many in expensive areas can consider home equity an investment if they plan to sell their home and move to a lower cost area when they decide to retire. Many buy investment property, but I won't consider this "investing" in this treatment of the topic as managing that property is actually a job and the cost of the properties is a business expense, not an investment. Thus, for this discussion, "Investments are stocks, bonds, mutual funds, CDs and anything else that you buy for anticipated appreciation and/or passive income."
What is "Allocation"?
Allocation is the mixture between different investment classes. I like to divide these into two broad categories: Fixed Income and Equity. Fixed Income includes short term bonds, CDs, T-Bills, savings accounts, etc. These investments produce income and have little interest rate risk due to their short term maturities. Long term maturities are more speculative where you put your principal at risk from changes in the interest rates. You can also add "junk bonds" to fixed income though their higher rate is due to their higher risk. The Equity class includes common stock and stock mutual funds. Equities are further broken down into categories of US vs. Foreign as well as large, midsized and small capitalization stocks.
How does one allocate their assets?
I believe this is best done with the help of an unbiased professional called a "fee only advisor". These people charge you a straight fee and do not sell you anything. People that sell you something and help you with your investment plan have a conflict of interest. The January 1998 issue of "Consumer Reports" has an excellent article "Financial fixers and fakers" that I highly recommend all go read. Their conclusion agrees with mine "Try and use a planner whose self interest is aligned exclusively with your own." This means they make money by giving good advice and having you come back and pay for more. A good plan can cost $400 for a rather simple one to several thousand dollars for a fairly complex situation. The article also suggested, if you have a complex situation, to start small and build slowly with your advisor.
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