Asset Allocation in Today’s Markets
by Bob Rippy
“Don’t put all your eggs in one basket.” Sound advice our grandparentsmay well have told us. But why, and how does one do this?
Individuals who invested heavily in technology stocks in the late 1990s when the bubble burst, or only in financial stocks recently, now know the why. But, the question is how to do it correctly going forward.
Investors could invest only on the risk-free sideof the spectrum, and that may be all people who are totally risk averse are comfortable with. But they would miss out on the long-term growth potential of stocks that can help protect their portfolio against inflation.
The asset allocation process, or investment diversification across different asset classes, determines 90 percent of investment performance and is the crucial factor of long-term portfolio success, according to a widely recognized academic study.
Most asset allocation plans are developed by determining the investor’s time horizon, investment goals, investable assets and their own risk tolerance. Risk tolerance can be measured by questionnaires and interviews with the investor. The level of investment sophistication, age and employment status are a few of the questions asked. Will the investor leave a large estate to heirs or charity, or spend it themselves? After gathering the pertinent data, a financial advisor can assign target portfolio percentages to stocks, bonds and cash in the most basic analysis.
In larger portfolios with more sophisticated investors, other classes may be added including, but not limited to, private money management, real estate, commodity based funds or other alternative investments. Each of the asset classes can be subdivided into large, mid and small capitalization stocks, growth and value stocks, international equity, emerging markets, and government, corporate, municipal, and international or high yield bonds, if the risk tolerance allows.
Finally after determining the allocations, the investor and his or her financial advisor should determine the appropriate portfolio implementation. Most investors would agree that diversification is desirable, but a large grab bag of similar investments is not diversification. Many investors are not diversified; they are just spreadout in a haphazard accumulation. An investor should determine if they are truly asset allocated.
Many investors start well with a diversified plan. They determine their risk tolerances, make a plan and invest accordingly. But they fail to follow upto rebalance, or reposition the assets back to the right baskets. Investing is cyclical and not all investments perform the same each year. A method is needed to get back to the correct allocations.
Most common is an annual review and rebalance. In an annual review, the financial advisor and client would review any life or investment view changes. Then, the portfolio is rebalanced or brought back to the agreed upon portfolio mix. This crucial step is often lacking. Many find it difficult to follow basic tenet of investing, sell what is up and buy what is down. Rebalancing achieves this. Without moving investment funds back to the original balance, the plan can start to fall apart. Properly implemented, the asset allocation process will lead to improved investment results and more consistent returns. 
Bob Rippy, CFP is Senior Vice President, Branch Manager at the Kansas City office of Robert W. Baird & Co.
P | 816.480.4213
E | RRippy@rwbaird.com