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Saturday, May 16, 2009

Asset Allocation

From the Hoss's Mouth

Research has shown that asset allocation is the single most important investment decision an investor makes. What is asset allocation? Hoss Cents Free Financial Money Magazine's definition is as follows:

The structuring of your investment portfolio with different asset categories using stocks, bonds or cash.

There is no specific asset mix that is perfect for each investor. The wise investor knows what his/her investment objectives are, what the time horizon is for achieving those objectives, and what risk they are prepared to take (also known as risk tolerance) .

Time Horizon - Your time horizon is the length of time in months, years, or decades you have to achieve your financial objective.

Risk Tolerance – How much risk you are prepared to take to achieve your financial goal. Are you an aggressive investor prepared to purchase risky investment for greater potential returns or are you a conservative investor, one who wants to preserve your original investment?

A rule of thumb used by many financial advisers is that the total percentage of fixed income held in your portfolio should approximately equal your age. In other words, if you are 45 then 45% of your portfolio should be fixed income. If you are 20 then 20% is fixed income. This is a good tool to start you on an investment path which includes an asset allocation strategy.

Hoss Cents Free Financial Money Magazine provides a slight modification to this asset allocation rule. First, assess your risk tolerance on a scale of one to ten. One being the most conservative investor, and ten being an investor willing to take extreme risks. Now combine the two factors of age and risk tolerance in the following manner: If your risk tolerance is 5, make no adjustment to the rule of thumb. For every number higher than 5, reduce the fixed income component by 5%. For every number lower than 5, increase the fixed income percentage by 5%.

Look at some examples provided by Hoss Cents Free Financial Money Magazine :

Risk tolerance of 7 and age 45. Fixed income component would be 35%: 45 (age) minus 10% (5% for each number above 5)

Risk tolerance of 7 and age 20. Fixed income component would be 10%: 20 (age) minus 10%

Risk tolerance of 2 and age 45. Fixed income component would be 60%: 45 (age) plus 15% (5% for each number below 5)

Risk tolerance of 2 and age 20. Fixed income component would be 35%: 20 (age) plus 15%

For those of us who do not have the time or the inclination to go out and purchase individual stocks and bonds, a simpler and easier method is to buy mutual funds or exchange traded funds. They provide an excellent method of diversifying your portfolio.

The Hoss hopes he has helped you in determining an asset allocation that will enable you to reach your investment objectives. Remember, all investments have some risk and you could lose some or all of your money.

Stay on track,

The Hoss

Next Hoss Cents Free Financial Money Magazine Post: May 24, 2009
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1 comment:

  1. I feel strongly that asset allocation can be the key to investing success. Most financial planners will include life insurance as part of your holdings. Many people will have a life insurance policy as protection for their familiy and when the kids are grown and gone let it lapse. I've recently discovered through life settlements that an investor will pay you for that policy that you might have thought was worthless. Working through a reliable company they can match an investor that will pay you for the death benefit your policy holds. So, I guess the bottom line is to include your life insurance holdings as part of your diversification plans but don't simply let it expire without checking out life settlements.



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