It has been more than a year and a half that I blog and read other blogs on daily basis. I noticed that many of them would trade on their own and determine their own asset allocation according to their financial knowledge and experience with the market. I thought it would be a good idea to go back to the basic and review the concept of asset allocation.
I am personally starting to appreciate the full potential of this investment technique. This is a 2 parts series on asset allocation where I will discuss the pro’s and con’s of this concept.
As I already mentioned, I started trading about three years ago. I opened a line of credit; I maxed it out and started my adventure in the stock picking world. While I did well enough to build sufficient cash down for my first house, I lost all my profit the year after, just before buying my second house. What was the reason? I tried to make a homerun and I concentrated most of my asset in that hit. I ended-up with a strike-out.
The worst part is that I was following two mining stock and decided to invest in only one. While the one I bought dropped from $1.20 to $0.50 in one day, the other one went from $1.00 to $25.00 in a span of a year. If I would have put half of my 10K on it, my wife would have stop working by now! But I would not call this diversification or asset allocation.
A good asset allocation is done when you invest money a little bit everywhere (liquidity, fixed income, Canadian Equity, American Equity, International Equity) and that your allocation goes with your investment profile. Don’t buy only emerging market because you think it is hot right now. It is true that it is quite a good place to put your money but are you prepared to get a 18% drop tomorrow morning? This could definitely happen in this kind of investment.
I often look at people’s investment and I notice that they their asset allocation is not optimal. What does this mean? Some people may have a high aversion to risk and have 20% of their portfolio in small caps because they were told they would make good money with this investment. Others may be very aggressive and would not mind a drop of 10%-15% of their portfolio but they have 45% invested in fixed income and liquid assets. In this case, their advisor didn’t want to have any problems and decided to go on the safe side. In both scenarios, the client is always the loser.
In the part 2, we will discuss different ways to have an optimal asset allocation and how to determine your investment profile. You might be surprised to find out what your portfolio look like and what you should have in order to really meet your investment needs!
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