Your Allocation Your Responsibility

Asset Allocation is the critical part in Modern Portfolio Theory (MPT); it will keep you in check all the time and bring your portfolio to proper portion. If you still young assuming 20-30, you need more return and you can take more risk therefore you should aggressively invest equity market. As you age between 40-60, your percentage in fixed income should be increasing every year until your retirement.

John Bogle, founder of the Vanguard group of funds, suggest that you should allocate your Bond allocation according to your age. For example, If you are 36 years old now; you should have 36% of Bond in your portfolio. I do believe that retirees should have at least 70% of their total portfolio in fixed income class like Treasury, Bond or CD instead of riskier securities like stock, futures, derivatives or options.

Asset Allocation: The idea that you minimize risk and increase a return by diversifying your money in several asset classes which uncorrelated to each others. Asset Classes available nowadays are

• Equity: Stock, FOREX, Options or Futures
• Fixed Income: Bond, CD, US Treasury like TIP (Treasury Inflation Protection)
• Commodity: Gold, Oil, Corn, Sugar, Precious metal like silver, lithium and etc.
• Real Estate: House or REIT (Real Estate Investment Trust)
• Cash: Reserved money when emergency situations approach

Those are major asset class that mainly uncorrelated !!! what does it mean ? It mean when some goes up; some will go down and vice versa. Bond normally have a reverse relationship with inflation. If inflation rate is low (below 2%), Bond price stay in high value and value tend to be lower as inflation rise. As we know, every governments in the world more likely to fight inflation from their boom economy because inflation will make living expensive plus high borrowing and lending rate.

For example, US government always try to keep inflation below 5%. However, Inflation is not that bad because it help stimulate small and large business; we just need to keep it in check often. A good number for inflation is approximately 2-3% a year.

If you wonder that your average return will keep up with inflation or not ? You need to subtract annual return with inflation. Let's say "You need a return 8% a year" so you need to make at least 11% on your portfolio because inflation will reduce your return by 3% every year. In you have broker account in US, you can hedge inflation using TIP (stand for Treasury Inflation Protected). This TIP will earn you the same rate as normal Treasury but it already absorb an inflation into account; it like you get pure 5% yield after inflation.

REIT (Real Estate Investment Trust) is also an excellent alternative investment for anti-inflation hedge because most of the time it uncorrelated with stock market.

Benjamin Graham suggested that a perfectly diversified portfolio carried a position in stocks, bonds, cash, and real estate. Here is Recommended Asset Allocation during Life-Cycle period.

Age 20-35: Style - Young and Aggressive

Stock 65%, Bond 20%, Real Estate 10%, Cash 5%

Age 36-45: Style - Consistency Return with average risk

Stock 55%, Bond 30%, Real Estate 10%, Cash 5%

Age 46-55: Style - Minimize risk with steady return

Stock 50%, Bond 35%, Real Estate 10%, Cash 5%

Age 56-65: Style - Conservative and Stream of Income

Stock 45%, Bond 37.5%, Real Estate 12.5%, Cash 5%

Age 65-80: Style - Safe Heaven before dust

Stock 25%, Bond 50%, Real Estate 15%, Cash 10%

As a general rule, you should know that with every 10 percent of exposure to equities/stocks, your portfolio will also carry a volatility of 1 percent. For example, a portfolio comprised of 50 percent stocks and 50 percent bonds should have a volatility of 5 percent greater than a portfolio that carries nothing but bonds.