The Asset Allocation Process: Introduction

By Patrick Rau, CFA ∙ May 2016

 

The GEICO ads say 15 minutes can save you 15% or more on car insurance. I’m hoping the 120 minutes or so it will take you to read this series of articles I’ve written on the asset allocation process can help you add that amount or more to the future value of your investment portfolio. No guarantees, of course, but a little work now may lead to a lot of gains later.

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The online financial website Business Insider published a great article in May 2016 that shows nearly half of Americans with a self-directed retirement plan have "no idea what they're doing" when it comes to managing their accounts, which suggests they might be better off seeking professional advice. However, there is plenty of academic research that shows the total fees these professionals charge can actually reduce the growth of your future account balance by a significant amount, perhaps by 50% or more, depending on the fees charged and one's time horizon. So what's an investor to do?

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I am convinced that novice and more experienced investors alike can put themselves in a much better position to enhance the earnings potential of their portfolios if they only knew a few things that financial professionals may not necessarily want the public to know, and where to find that information quickly and easily. The nine articles in this series are designed to do just that.

 

As soon as people discover that I once worked on Wall Street, I usually get some form of the question “where should I be investing my money?” I’m asked this question from people from all walks of life. Doctors, lawyers, teachers, laborers, artists, computer scientists, recent grads, those nearing retirement, you name it. I’ve found that those who ask are usually people who feel they are too busy to make their own investment choices, and/or more likely, are folks who simply don’t trust themselves to make such decisions.

 

The basic rule on where one should invest his or her money – the asset allocation question –  is that it depends on one’s particular circumstances:  his or her specific investment return goals, and his or her willingness and ability to accept risk. For example, younger investors with plenty of disposable income who are saving for retirement should be more heavily weighted in stocks, while a retired couple with current income needs, or someone who plans to make a major purchase in a year or two, should have a higher weighting toward cash and fixed income securities. Oh yes, that’s very nice (a reference for you Monty Python fans). But what portfolio allocation is right for me? 

 

I am not a financial advisor, so I am not in a position to recommend a specific asset allocation for anyone. However, my goal in writing this series on the asset allocation process is to help you make more informed decisions on your own, whether that entails your taking a more active role in managing your portfolio, or hiring an investment professional to handle some or all of that for you. If you already have a financial professional, these writings should enable you to ask him or her more informed questions, in order to help ensure you are getting the most appropriate advice.

 

These articles are based on things I have learned from my MBA curriculum, the Chartered Financial Analyst (CFA) program, time spent as an equity research analyst on both the sell-side for an investment bank and the buy-side for an investment advisory firm, and from many books and financial articles I have read throughout the years, including some of the very latest groundbreaking financial research.

 

Some of the material I present may be pretty boring and a little technical at times, but I try to explain this stuff as quickly and painlessly as I can. To help make things a bit less tedious, I have broken this into a series of individual articles, and finished with a checklist that summarizes the main steps. These are meant to be read in order, but you can certainly skip around if need be, or go back and re-read particularly relevant sections at a later date. Perhaps for now you are only interested in ideas on how to allocate your 401k contributions. If so, you’ll want to pay particular attention to Parts 1-3. In the market for a financial advisor? Then please give Part 6 a read. Are you in or nearing retirement? Part 8 addresses some of the latest industry thinking in how to withdrawal your retirement funds in a more efficient manner.

 

Part 1: Historical Asset Class Returns

Part 2: Modern Portfolio Theory in Five Minutes

Part 3: The Asset Allocation Process

Part 4: Mutual Funds vs. Exchange Traded Funds (ETFs)

Part 5: Managed vs. Index Mutual Funds

Part 6: Should I Hire an Investment Professional?

Part 7: Things That May Improve Your Portfolio’s Performance

Part 8: Thoughts on Retirement Spending

Part 9: Diagnostic Portfolio Checklist

 

 

Finally, I should note that while I have written these articles for investors in the United States, most of these concepts should translate to other parts of the world as well. Maybe not the specific math behind some of the examples, since things like tax rates and regulatory regimes differ from country-to-country, but many of the basic ideas should still apply.

 

I hope you find these articles to be helpful, and I invite you to kick things off with Part 1: Historical Asset Class Returns.

 

All the best.

 

 

- Pat

 

 

Patrick Rau, CFA, is a former equity research analyst, both on the sell-side specializing in energy and the buy-side as a generalist for a financial advisory firm. He holds a B.A. in Economics from the College of William & Mary, and an MBA in Finance from Georgetown University. He is married to Brenda Rau, Licensed Real Estate Salesperson with Compass Real Estate in New York City.

 

Disclaimer: All information and calculations are based on information deemed to be reliable. Patrick Rau, CFA is not an investment advisor, and this paper is for educational purposes only. Nothing herein should be considered financial or investment advice. Moreover, Patrick Rau, CFA shall not be liable for any losses or damages that may result from any decisions you make based on any of this content.