Fundamentals Of Asset Allocation

Savings and Investments Singapore AAM Advisory

The fundamentals of asset allocation are child’s play.

Offer a 6-year old a choice of 20 sweets from a much larger range that they haven’t had before, and see whether they choose the same ones.

On second thoughts, why not try this on someone else’s kid instead… chances are they wont risk choosing 20 similar sweets in case they’re actually vitamins in disguise, they’ll probably hedge their bets and choose different ones.

The fundamentals of asset allocation are pretty much an extension of this.

Don’t put all your eggs in one basket. We’ve all heard this before and it simply means don’t take big risks.

For A Professional Financial Planner The Fundamentals Of Asset Allocation Boil Down To Encouraging Clients To Build Up A Variety Of Different Assets

As an example, the past decade has been a great time to have held property. This has led many to believe that property is the only thing worth investing in.

Young people coming to the market now will have been told by their parents that it’s important to get on the ‘property ladder’, and the number of buy-to-let property investors has increased dramatically even whilst globally property markets have been suffering.

Is it likely that property will generate returns in the next decade as good as those from the last decade? Well, who knows, but even if not, does that mean don’t buy property? Of course not.

The fundamentals of asset allocation suggests it makes sense to try and balance out the assets that you invest in. This is because in different parts of the economic ‘cycle’ different assets will perform differently.

We currently have very low interest rates in many parts of the world, but if, or when, interest rates rise, many first time investors may find financing a property becomes too expensive.

However, in periods of rising inflation (which could have caused those interest rates to rise), commodities and ‘real assets’ tend to do quite well. Also, in periods of rising interest rates, bonds (those investments which involve lending money to a government or corporation), tend to perform very poorly.

It’s very difficult to predict how quickly this economic cycle will turn, and therefore the fundamentals of asset allocation are to buy lots of different assets to reduce the risk that you only have say property when the market crashes.

Portfolio Managers Working For Large Pension Funds And Institutions Are Probably The Greatest Proponents Of Fundamental Asset Allocation Methods

These organisations have long-term liabilities to meet and therefore they cannot afford to make big bets on a particular asset, hence they will usually buy a broad spread of equities, property, bonds, cash, commodities etc.

Portfolio managers use mathematical tools to try and ensure that the assets that they invest into perform in a different way (are less correlated) in different parts of the economic cycle. In this case ‘diversification’ is the ultimate goal, and this is purely an extension of the ‘eggs and baskets’ argument, and hence related to the fundamentals of asset allocation.

The financial crisis of late 2008 was a great test for this approach. Indeed, whilst almost all investments suffered, government bonds, gold and some hedge funds all made money.

Clients who had applied the fundamentals of asset allocation should have found that their overall net worth was impacted less severely than it would otherwise have been.

The fundamentals of asset allocation are, therefore, entirely logical and a fairly common-sense part of the financial planning process and certainly much easier than trying to calm down that sugar-filled hyperactive child you created.