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Asset Allocation Without Reservation


Did you review your portfolio this year?

 

Before coming into this business, I thought I was diversified by having my investments in a Vanguard S&P500 index mutual fund. I figured. Hey, I’m across 500 stocks, that’s diversification. In reality, all my holdings were in one asset class, large-cap domestic stocks. Real diversification includes many categories of investments including but not limited to small stocks, large stocks, international stocks and bonds.

 

As far as asset-class winners and losers, the last time large stocks gave the highest return was in 1998. Since then, bonds and international stocks performed better. So why diversify? Winners rotate; you don’t want to miss out on the best performing asset classes.

 

To reduce the volatility of returns in a portfolio, combine assets that tend to have low correlation to one another.

 

For example, a rock group needs musicians with different attributes and talents – the group must be diversified. Building a group with four guitar players is not a great idea, as much as we like guitar players. A singer is needed, as well as a drummer. Because they have different attributes and talents, the correlation between guitar player and drummer is low – and low correlation is what you're after.

 

Low correlation equals diversification. Economics professor Harry Markowitz summarizes the basic premise underlying diversification and portfolio asset allocation in one sentence: “To reduce risk, it is necessary to avoid a portfolio whose securities are all highly correlated with each other.”

 

A preferred asset allocation should be based on your investment goals, risk tolerance, age and your time horizon. A portfolio of all stocks or all bonds may not be appropriate for you. A balance of many asset classes is ideal.

 

For further information on this topic feel free to call me and set up a consultation. James Shagawat, jamess@baron-financial.com, www.baron-financial.com.

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Comment   |  6 years, 5 months ago from Fair Lawn, NJ