Personal Finance

Asset Allocation is the process of dividing investments among different kinds of asset classes (such as stocks, bonds, cash, real estate, commodities, etc.) to try to meet specific financial goals.  Research shows (Brinson, Hood & Beebower, 1986) that over 90% of investment portfolio performance over time is explained by the asset allocation decision. Thus asset allocation is so important, way more than security selection.

Do not believe the myth that diversification can be achieved with 10-30 individual stocks.  Academic research indicates that it takes at least 60 randomly selected individual stocks to eliminate 88% of diversifiable (uncompensated) risk.  Build a $250,000 core portfolio with low cost index funds or at least 60 individual stocks from different industries and countries.

For this core portfolio, adopt a financial asset allocation target of equity mutual funds and interest earning vehicles.  The split between these groups is based on your risk profile.  As you build wealth with this proven strategy, you create the solid foundation which increases your risk capacity. Your asset allocation will also change to match your increased risk capacity as your overall financial position on the Financial Life Cycle improves.

Use Morningstar’s fund screener to find mutual funds under these categories.  We recommend passively managed or index funds with low expense ratios.

There are many strategies for changing your financial asset allocation to more closely proximate the model of middle income millionaires.  All the strategies accomplish the same goal, but differ in terms of:

• Transaction costs
• Tax consequences
• Complexity
• Time to implement
• Financial benefits ($$$) to you
• Your emotional resistance

These strategies include:

• Liquidating portfolio equity assets and reinvesting in interest earning assets
• Invest 100% of your new IRA contributions/salary deferrals into interest earning assets until you achieve the target.
• Purchasing  US Savings bonds with after-tax dollars
• Some combination of the above