Why the Old Rules of Assets Allocation Should Be Thrown out the Window
By Sasha Cekerevac for Daily Gains Letter |
There are many rules that people have come up with when it comes to asset allocation that need to be revised. Several deal with preventing investor mistakes, while some are erroneously placing capital where it will tend to underperform the market over the next decade.
Asset allocation is an extremely important part of one’s portfolio. Investor mistakes in asset allocation will lead to severe underperformance to the market, or worse, a shortfall in expectations for retirement savings.
One of the asset allocation models that should be thrown out is keeping only a small portion of a portfolio in foreign investments. While America is still a large economy worldwide, there are many parts of the world that are growing extremely quickly. There will be many investor mistakes from people keeping too much weighting in asset allocation on domestic companies.
While investing in emerging markets can be difficult, there are certainly a growing number of exchange-traded funds (ETFs) that allow for portfolio diversification and a greater amount of diversity in one’s asset allocation model.
While many picture emerging markets as just poor citizens, nothing can be further from the truth. As nations get wealthier, there are a growing number of citizens moving up into the middle class, which means increased amounts of disposable income available for consumption. This is evident all over the world, including Asia, South America, and Africa.
One of the leading investor mistakes is waiting until a nation is fully developed before investing. Some of the best capital appreciation investments stem from being early, as a nation moves up in wealth.
Another asset allocation mistake is the distribution between equities and fixed income. Many investor mistakes stem from the old rule of increasing fixed income assets, while decreasing equities exposure as one ages. The problem with this asset allocation model is that with the current financial repression of interest rates, there is not much left for income from interest rate yields.
When we compare the dividend yield of the stock market versus the U.S. fixed income market, clearly, the relative value favors equities. Even with the substantial move up in the stock market since 2009, a more aggressive asset allocation model favoring equities makes sense over the next decade.
As with everything in life, there are no guarantees. In fact, one of the biggest investor mistakes when it comes to asset allocation is making an investment based on the belief that it is a sure thing. There is no such thing as a safe investment. Even cash is not safe, as it is slowly eroded by inflation. Housing is not safe, as we’ve seen, and even gold is not safe, as it, too, declined in value during the last crisis.
Don’t fret over the inability to find safe investments, but be opportunistic and take advantage of volatility in entering markets when many are exiting. As it stands right now, many investors are piling into the fixed income market, which is leading to riskier investments. I think that from a relative basis, the equity market is far more attractive than U.S. Treasuries in an asset allocation model over the next decade.
As with all things in regards to asset allocation, one must carefully conduct due diligence and risk analysis for each individual’s portfolio. Obviously, some investors can and are able to take on greater risk, which comes with greater potential for rewards. The point is to avoid investor mistakes by being part of the herd. When a market is crashing, this is the time to start looking for buying opportunities.