By Raymond D. Mignone
Many Queens retirees still do not have well-diversified investment portfolios and because of this continue to endure large losses to their net worth. Does this sound like you?
Unfortunately, there is no one-asset allocation plan suitable for all investors. You need to evaluate your risk tolerance, time horizon for investing, and return needs to determine how you should allocate your portfolio among the various investment categories. Holding on to large positions in individual stocks simply because you inherited them or owned them for many years adds great risk to your overall net wealth.
The theory behind asset allocation and diversification is that different investment categories are affected differently by economic events and market factors.
Some asset classes move in opposite directions while others move in the same direction at different times. By owning different types of assets, it is hoped that when one asset suffers a major decline, other assets will be increasing in value. For example over this past year bonds and REITs have held up very well.
Investments with higher return potential generally have higher risk and more volatility in year-to-year returns. While most investors want higher returns, they maybe uncomfortable assuming higher risk levels. Asset allocation allows you to combine more aggressive investments with less aggressive ones. This combination can help reduce the overall risk in your investment portfolio.
Not only should you diversify across broad investment categories, such as stocks, bonds, and cash, you should also diversify within those categories. For instance, within the stock category, consider large-capitalization stocks, small-capitalization stocks, value stocks, growth stocks, and international stocks.
Assessing your risk tolerance is one of the most important, yet most subjective, parts of determining your asset allocation. You are trying to assess your emotional ability to stick with an investment when returns are less than expected. From my experience it is very hard for most individuals to objectively determine the correct risk level of their portfolio. People tend to be very aggressive when the market is up and fearful when the market is down. In most cases working with a professional advisor allows an objective voice to keep you from making costly mistakes based on short-term emotional swings.
The longer your time horizon, the more aggressive your portfolio can be, since you have more time to overcome downturns in investments. Those with a time horizon of less than five years should not be invested in stocks. Look at cash and bonds for those short-term needs. As your time horizon lengthens, you can add higher percentages of stocks to your portfolio.
Make sure you have reasonable return expectations for various investment categories. Basing your investment program on return estimates that are too high could cause you to increase the risk in your portfolio in an attempt to obtain higher returns. In the past few years this has been one of the biggest mistakes investors have made.
In general, you should consider a more conservative allocation if you are older, have short-term needs of your money, have a low risk tolerance, or are uncomfortable with investing. A more aggressive allocation may be indicated if you have higher earnings, are younger, do not need your money for many years, or you are an experienced investor. The amount of any fixed pension income is also a very large consideration.
Rebalance your portfolio at least annually. Over time, your actual asset allocation will stray from your desired allocation due to varying rates of return from your different investments. Changes may be needed to bring your allocation back in line. We rebalance our client’s portfolios more frequently adjusting the mix of investments to take advantage of current market conditions. By intelligently utilizing tactical asset allocation you can be successful in reducing your losses in this bear market and position yourself for the eventual market rebound.
Raymond D. Mignone is a fee-only Certified Financial Planner & Registered Investment Advisor specializing in retirement planning and investment management; he can be reached in Little Neck at 229-2514 or at www.raymignone.com.
