Monday, September 28, 2015
It's one of the simplest ideas in all of investing...
And it's one of the most important.
Today, we suggest taking some time to think about your "asset allocation"...
Once you get started, it shouldn't take you more than an hour per month... And it could save you hundreds of thousands of dollars over the course of your life.
Asset allocation is the component of your wealth plan that deals with the amount of money you have in various assets. How much of your wealth do you hold in cash? Stocks? Bonds? Gold? Real estate? This all falls under the umbrella of asset allocation.
The No. 1 goal with asset allocation is to avoid making huge bets in just one asset class. This way, you're not vulnerable to losing everything if one idea doesn't work out.
For example, people who put all their wealth in tech stocks back in 1999 were completely wiped out when the tech market crashed in 2000-2002. More people were wiped out during the 2006-2009 real estate crash because they placed all their wealth in overpriced homes. The key to investment success is to avoid these catastrophic losses that destroy retirement nest eggs.
Below, we'll revisit a simple asset-allocation plan we shared with you in January. And we'll demonstrate – with actual prices – how it not only reduced volatility this year... but also improved gains.
On January 12, we showed you "how to build a portfolio that will handle any crisis." Here's the breakdown of our "middle-of-the-road" asset-allocation plan:
Precious metals: 5%-10%
Real estate: 20%-30%
In our essay, we explained how to think about each asset class. For example, for real estate, we said:
Take a look back at that essay for more details on how to allocate your wealth. Today, we're focusing on performance... using a simplified version of our asset-allocation plan.
For our bond allocation, we're looking at the performance of Nuveen Municipal Opportunity Fund (NIO).
For precious metals, we're using the Central Fund of Canada (CEF). This fund holds a mix of physical gold and silver.
For cash, we'll use the U.S. dollar (which doesn't change, in dollar terms).
For real estate, we're using the median price of existing homes sold in the U.S. This is a monthly figure.
And for stocks, we're using the S&P 500 Total Return Index. This index tracks the percent change in the S&P 500 and includes dividends.
You can see the performance of all these assets so far this year in the chart below...
If you had all your money in stocks, you would have experienced a gut-wrenching 11.1% drop in your net worth last month. Year-to-date, you would be down 4.7%.
But if you had followed our middle-of-the-road asset-allocation plan, you would have fared much better.
In the hypothetical portfolio below, we divided our money between the different asset classes on the first day of the year.
Specifically, we allocated our money like this:
Precious metals: 10%
Real estate: 25%
As you can see below, with this diversified portfolio, the worst drawdown (peak to trough) you would have experienced was 3.4%... from late January to early March. As of Friday, your net worth would be up 0.7% on the year.
This is a simple example. But it tells an important story...
When you practice intelligent asset allocation, market corrections like the one last month will barely register on your radar. You'll have a diversified portfolio with components that "zig" when other components "zag." More importantly, in the case of an all-out financial storm, you'll prevent catastrophe.
Take an hour to think about your holdings today. It could turn out to be the most valuable 60 minutes you spend all year.
Brian Hunt and Ben Morris
"Lots of investors have an important question on their minds right now," Brian and Ben write. "Should I be worried about a crash?'" They say the answer is YES... if that's what it takes for you to put a catastrophe-prevention plan in place. Get all the details here.
Dr. David Eifrig says he has "seen ignorance of [asset allocation] ruin more retirements than any other financial factor." Learn more about smart asset allocation in this interview with Doc.