Asset Allocation Made Simple! A Guest Post by Greg Phelps CFP®
I want to thank Greg Phelps CFP®, President of Red Rock Wealth in Las Vegas, for joining us and providing his expertise on Asset Allocation. The analogy for asset allocation I like use is baking a cake. The asset allocation is recipe for baking your cake, the stocks/bonds/mutual funds/ETFs are your ingredients, the cake is your portfolio. I really like the way Greg explained the importance asset allocation and I hope you will too!
We talk about it all the time, you may even hear it on the news if you’re watching financial channels – but what exactly is asset allocation? Simply put, asset allocation is the process of dividing up your investments into groups of similar securities then allocating distinctly separate amounts of your investment capital in them.
Why would we do this? Because groups of similar securities grow and fluctuate similarly to each other, but relatively different to other groups of securities. By matching these groups together in different percentages you can reduce your overall portfolio risk and volatility. When stocks go up for example bonds may drop or stay flat, and vice versa.
It’s very important to note that the allocation plan must revolve around not only your risk tolerance, but your financial plan. We invest in stocks according to a solid retirement plan (as does Stephen Reh). After working with investors for over 20 years it still baffles me how most investors act like Nike and “just invest” without taking the time to match their investment plan with their financial goals and objectives.
Most experts believe that the importance of the individual investments and securities within your portfolio is a distant second to the percentages into which they are allocated. Study after study has shown that it’s not what stocks, bonds, or mutual funds you invest in, it’s the percentage allocation of assets such as stocks, bonds, cash and commodities that determines over 90% of your investment results!
So just what are asset classes?
There are three main assets classes utilized in generating an asset allocation model for your investment portfolio. All assets within each class exhibit similar characteristics. They are:
- Equities (Stocks)
- Fixed Income (Bonds)
- Cash Equivalents (Money Market Instruments)
Some financial advisors and investors would add commodities to the list of primary asset classes. We believe indeed it is a primary asset class because it has illustrated very little correlation to the other asset classes. By correlation, we mean it fluctuates up and down in value highly independently from the other asset classes. For example, last year commodities plunged 20%+ while US large stocks were about flat.
That difference in movement is what we refer to as “non-correlation”. It’s the degree (or lack thereof) in which one asset class moves relative to another. The three or four main asset classes have very low or even negative correlation to each other. By allocating different amounts to them you can reduce your investment account fluctuations overall.
But what about different types of stocks or bonds?
The three or four primary asset classes can further be broken down into smaller groups of similar securities. We’ll call those “sub asset classes” for simplicity. The degree of correlation rises as each group is broken down further and further because the similarities between them rises.
Some sub asset classes include but are not limited to:
- Large Value Stocks
- Large Growth Stocks
- Small Value Stocks
- Small Growth Stocks
- International Developed Stocks
- Emerging Market Stocks
- Real Estate or REIT’s
- Short Term Bonds
- Intermediate Term Bonds
- Inflation Protected Bonds
- High Yield Bonds
- International Bonds
The benefits of asset allocation
A primary goal for any investment plan is to mitigate investment risks, while maximizing potential investment returns. This can be done most effectively with proper asset allocation and broad portfolio diversification.
If you have any concerns whatsoever about investing in the stock market, bond market, or even cash and commodities you should give Stephen Reh a call and make sure your asset allocation is in line with your financial plan. Market bumps shouldn’t concern you if you’re plan is solid, and it will be if you take the time to work with Stephen.
Greg Phelps, CFP®, CLU®, AIF®, AAMS® is the president of Redrock Wealth Management, a fiduciary financial advisor in Las Vegas. Redrock is a member of the National Association of Personal Financial Advisors like Stephen Reh, and specializes on retirement transition and decumulation planning.
Greg, thanks again for accepting the invitation to contibute to www.investwithsteve.com. You expertise is appreciated. If you are in the Las Vegas area and looking for a fee only financial advisor, I recommend giving Greg a call.