Asset allocation is one of those tricky topics that’s simple on the basic level but can become insanely complicated as you dig deeper. For people who have a lot of money, the subject can get so complicated they need to hire someone to manage it for them. For most of us, though, it shouldn’t be that hard.
Fundamentally asset allocation is simply how you divide up the money you have to invest. The object is to spread that money around to different types of assets so you don’t have your entire retirement nest egg in one basket. The idea is that different types of investment assets perform differently depending upon market conditions. Investment assets can include stocks, bonds, hard assets and cash. It should be noted that not every source on the subject includes hard assets in the mix of major asset classes. The reasons for this may include the fact that your advisor doesn’t sell or understand specialized markets like real estate or precious metals. It’s understandable, particularly given that we’re inclined to advocate for things we understand (and can potentially profit from). But if you owned gold, rental properties or commercial real estate last week you slept a lot better.
Also, although most investment advisors recognize anything you can sell for money, including a house, car, timber, jewelry, or collectible coins can be considered a hard asset, they know that doesn’t necessarily make it an investment grade asset.
The idea behind having a diverse mix of assets is to smooth out the volatility when one runs into trouble. This past week and a half that lesson was driven home to people who had too much of their assets allocated to the stock market; people who have just lost a lot of money. But by maintaining a fixed percentage of your money in different asset classes, you can reduce the shock of market volatility to your bottom line.
Spreading the Risk
A typical asset allocation might be keeping sixty percent of your assets in stocks, twenty percent in bonds, five percent in cash and five percent in high quality gold and silver bullion. The problem? That’s a lot of risk, because after another week like the one we’ve just had sixty percent of your wealth could be hanging from the shredder.
Of course the exact mix will depend on your age and tolerance for risk. Some people carry as little as twenty percent of their portfolio in stocks. That would be a conservative portfolio that limits the downside of a market crash but similarly gives up the higher returns when the market’s flying high. It’s your money and how much risk you’re willing to accept is a choice no one else can make for you. But you need to know the risks going in, because a surprise in this area might be a devastating financial blow from which you’ll struggle to recover.
Allocating for Volatile Markets
If volatility scares you, if news of a stock market crash makes you rush to check your 401(k) balance, there are ways to mitigate that unpredictability by reducing the percentage of your assets in the stock market and shifting more money to bonds, cash and hard assets.
You can also make changes within asset classes. In equities, this would mean shifting your focus from growth stocks to stocks and funds that focus on income, and industries that continue to generate revenue when markets are weak. Examples would include stocks like utilities, since people still have to pay for electricity and water even in a down economy; and real estate investment trusts (REITs) that hold income-producing properties like apartments and office buildings.
High quality gold and silver assets provide a buffer against currency devaluations and inflation, thus gold tends to be where investors flee when global equity markets crash. Investment-grade assets like Gold and Silver American Eagles are easily redeemed for cash and can even be held them in an IRA, an increasingly popular choice as boomers realize their stock portfolios won’t have time to recover after the next major downturn.
In bonds you’d want to transition away from high yield and high risk bonds, sometimes called junk bonds, and switch to safer debt, like municipal bonds. Municipal bonds are how cities and local governments raise money for improvement projects and spread the payments out so they’re more manageable. You can buy municipal bond funds individually or in specific funds which may hold bonds from many areas. Some municipal bonds are also tax free and the money can help out locally, if you choose to invest in hometown projects.
Too many people conflate the words “investing” and “stock market” when the reality is there’s a world of high quality investment assets that can be tailored to fit your personal situation, tolerance for risk, and need for secure income as you get closer to retirement. All knowledge is power, but understanding your investing options is a superpower.