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- Herausgeber: John Wiley & Sons
- Kategorie: Ratgeber
- Sprache: Englisch
An easy-to-understand how-to guide to the single most important thing you can do in investing -- choosing and mixing your assets successfully. You don't need to be an expert analyst, a star stock-picker, or a rocket scientist to have better investment results than most other investors. You just need to allocate your assets in the right way, and have the conviction to stick with that allocation. The big secret behind asset allocation -- the secret that most sophisticated investors know and use to their benefit -- is that it's really not all that hard to do. Asset Allocation For Dummies serves as a comprehensive guide to maximizing returns and minimizing risk -- while managing taxes, fees and other costs -- in putting together a portfolio to reflect your unique financial goals. Jerry A. Miccolis (Basking Ridge, NJ), CFA®, CFP®, FCAS, MAAA is a widely quoted expert commentator who has been interviewed in The New York Times and the Wall Street Journal, and appeared on CBS Radio and ABC-TV. He is a senior financial advisor and co-owner of Brinton Eaton Wealth Advisors (href="http://www.brintoneaton.com/">www.brintoneaton.com), a fee-only investment management, tax advisory and financial planning firm in Madison, N.J. Dorianne R. Perrucci (Scotch Plains, NJ) is a freelance writer who has been published in The New York Times, Newsweek, and TheStreet.com, and has collaborated on several financial books, including I.O.U.S.A, One Nation, Under Stress, In Debt (Wiley, 2008).
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Veröffentlichungsjahr: 2009
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Asset Allocation For Dummies®
Table of Contents
Introduction
About This Book
Conventions Used in This Book
What You’re Not to Read
Foolish Assumptions
How This Book Is Organized
Part I: Discovering the Not-So-Secret Recipe for Asset Allocation
Part II: Getting Started
Part III: Building and Maintaining Your Portfolio
Part IV: Going beyond the Basics
Part V: The Part of Tens
Icons Used in This Book
Where to Go from Here
Part I: Discovering the Not-So-Secret Recipe for Asset Allocation
Chapter 1: Understanding Asset Allocation
Figuring Out Why Asset Allocation Is So Important
Encapsulating the Enron story
Exploiting the 90 percent solution
Uncovering the Basics of Asset Allocation
Balancing risk and return
Selecting your asset classes
Determining your asset mix
Rebalancing your asset mix
Getting Started with Your Investment Strategy
Building Your Portfolio and Keeping It True to Your Long-Term Goal
Selecting securities
Mastering asset location
Monitoring your portfolio to stay on target
Measuring your results
Reaching Past the Asset Allocation Basics
Adding alternatives
Tackling taxes
Altering your allocation
Embracing expert help
Chapter 2: Weighing Risk and Return
Measuring Return
Total return and its components
Nominal return versus real return
Understanding time-weighted return versus dollar-weighted return
Annualizing multiyear returns
Accounting for taxes, fees, and expenses
Measuring Risk
Differentiating between volatility and risk
Understanding how volatility erodes return: Risk drag
Using statistical measures for risk
Factoring in your time horizon
Evaluating the Trade-Off between Risk and Return
Recognizing that there’s (usually) no such thing as a free lunch
Heading for the efficient frontier
Chapter 3: Making Sense of Asset Classes
Identifying the Traditional Classes
Embracing equities: Stocks and stock funds
Getting a handle on fixed-income investments: Bonds, bond funds, and more
Capitalizing on cash and cash equivalents
Understanding Alternative Investments
Looking at your options for alternative investments
Knowing when to add alternative investments to your portfolio
Going Global with International Investments
Chapter 4: Determining the Right Proportions: Your Asset Mix
Putting the 90 Percent Solution to Work for You
Keeping your eye on the important 90 percent: Allocating your assets
Avoiding focusing on the other 10 percent
Embracing asset allocation’s guiding principle
Laying the Foundation for Successful Asset Allocation
Understanding correlation
Discovering the appeal of non-correlated assets
Finding the holy grail of asset allocation: Perfect negative correlation
Seeking stability and vanquishing volatility
Recognizing the Most Important Features of an Asset
Chapter 5: Stirring the Mix: Portfolio Rebalancing
Getting Your Free Lunch with Rebalancing
Understanding the Power of Rebalancing
How rebalancing works: Unlocking the energy of the periodic table
Making volatility work for you: Volatility pumping
Memorizing the mantra: How rebalancing forces you to buy low and sell high
Being a contrarian: Making sure you have the right mindset for rebalancing
Following the Right Rebalancing Schedule
Rebalancing on fixed calendar dates
Planning your rebalancing for the greatest opportunity
Part II: Getting Started
Chapter 6: Laying the Foundation for Your Plan
Seeing Your Investment Horizon Clearly
Setting Your Return Objectives
Making Decisions about Your Risk Tolerance
Evaluating your experience
Considering risk questionnaires and other tools
Setting Your Portfolio Constraints
Recognizing positions you won’t get out of
Identifying investments you won’t consider
Limiting your exposure to certain asset classes
Reviewing Your Tax Situation
Being mindful of your current and future tax brackets
Looking for opportunities in prior tax returns
Considering which of your assets are in tax-deferred accounts
Taking Account of Special Circumstances
Protecting your assets from lawsuits
Protecting your estate from taxes
Simplifying your holdings
Chapter 7: Developing Your Investment Strategy
Understanding the Lifetime Cash-Flow Projection
Getting a feel for the basics
Recognizing the link between your asset allocation and your Lifetime Cash-flow Projection
Coming Up with an Outline for Your Long-Term Financial Plan
Assets
Liabilities
Income
Expenses
Putting It All Together: Making Lifetime Cash-Flow Projections
Putting It All Together: Making Lifetime Cash-Flow Projections
Salary and other income
Expenses
Investment returns
Taxes
Savings or withdrawals
Assets
Liabilities
Testing “What If” Scenarios
What if you retire early?
What if you start a family or have more children?
What if you want to change your career?
Determining How Your Asset Allocation May Affect Your Lifetime Cash-Flow Projection
Estimating returns
Reckoning risk
Working risk and return into your Lifetime Cash-flow Projection
Documenting Your Strategy: Drafting Your Investment Policy Statement
Chapter 8: Creating Your Allocation Plan
Selecting Your Asset Classes
Establishing Your Asset Class Mix
Go long! Finding percentages for the long haul
Picking the right percentages
Looking at Some Sample Allocation Percentages
Aggressive: Higher equity percentage
Conservative: Higher fixed-income percentage
Moderate: Right in the middle
What about Subclasses?
Figuring out your fixed-income subclass allocation
Establishing your equity subclass allocation
Arming your portfolio with the appropriate alternative subclasses
An Asset Allocation Case Study
Setting Up a Schedule to Revisit Your Plan
Part III: Building and Maintaining Your Portfolio
Chapter 9: Buying Securities
Deciding What to Buy
Individual securities
Funds
Other investments
Figuring Out How to Buy Securities
Buying through a broker
Buying on your own
Understanding Fees and Expenses
Mutual-fund fees
Brokerage fees
Chapter 10: Knowing Where to Put Your Assets: Asset Location
Viewing Your Accounts Holistically
Considering taxable accounts
Understanding tax-deferred and tax-free accounts
Understanding the Tax Characteristics of Your Investments
Considering the tax efficiency (or inefficiency) of your investments
Knowing where to locate investments based on tax characteristics
Going through the Asset Location Exercise
Chapter 11: Monitoring Your Portfolio: Rebalancing and Other Smart Strategies
Rebalancing Your Portfolio
Dealing with portfolio drift
Rebalancing back to target
Rebalancing close to target
Using a working layer of exchange-traded funds
Keeping Tabs on Your Securities
Knowing when to hold ’em and when to fold ’em
Taking some winnings off the table
Setting your security guidelines early
Making Smart Tax Choices
Paying attention to taxable gains and losses
Deferring and offsetting taxable gains
Harvesting tax loss opportunities with exchange-traded funds
Chapter 12: Measuring Your Results
Figuring Your Investment Return
Calculating your return
Determining the return that’s most meaningful to you
Recognizing that making money isn’t necessarily the same as doing well
Comparing Your Return to Relevant Benchmarks
Knowing which indexes to use, and how to use them
Blending benchmark indexes
Tracking Your Progress against Your Long-Term Plan
Determining suitability with a little common sense
Determining suitability with a Lifetime Cash-flow Projection
Part IV: Going beyond the Basics
Chapter 13: Walking to the Beat of a Different Drum: Opting for Alternative Investments
Identifying Investment Alternatives
Regarding real estate
Harboring hard assets
Holding hedge funds
Exploring more exotic choices
Tapping the Power of Investments That Zig when Others Zag
Deciding When to Go Alternative
Hanging on for the alternative investment ride
Paying enough attention to alternatives
Chapter 14: Managing Your Taxes like a Pro
Playing It Smart When Selling Securities
Identifying the information you need
Figuring the tax implications of your transactions
Locating Your Assets Properly
Understanding tax-advantaged accounts
Considering an asset location example
Harvesting Tax Losses
Staying alert to tax-loss opportunities
Using exchange-traded fund swaps to harvest tax losses
Keeping clean when it comes to wash sales
Tax Sensitivity: Good in Small Doses
Chapter 15: Knowing When to Revise Your Plan
Identifying Life Events That Should Trigger a Review
Gradual life changes
Sudden life changes
Keeping Your Eye on the Economy
Recognizing major economic shifts
Paying attention to the business cycle
Considering a Lifetime’s Worth of Examples
Stage 1: Married 30-something parents
Stage 2: Stay-at-home Jane and a hiccup in the economy
Stage 3: Failing health and an unexpected windfall
Stage 4: A grand gesture for the grandchild
Chapter 16: Finding Help When You Need It
Knowing the Right (and Wrong) Reasons to Hire an Advisor
The right reasons
The wrong reasons
Weighing Your Options for an Advisor
Making sense of all those letters after an advisor’s name
Knowing what kind of expertise you need
Asking the Right Questions
Understanding How Advisors Earn Their Income
Fee
Commission
Fee plus commission
Performance incentive
Part V: The Part of Tens
Chapter 17: Ten Asset Classes and Subclasses and Their Historical Rates of Return
Cash
Corporate Bonds
Treasury Bonds
Municipal Bonds
Real Estate
Commodities
Large-Cap Stocks
Mid-Cap Stocks
Small-Cap Stocks
Emerging-Market Stocks
Chapter 18: Ten Common Asset Allocation Mistakes
Ignoring Asset Allocation in the First Place
Believing That Diversification Is Enough
Forgetting to Rebalance
Not Having a Long-Term Plan
Indulging Your Emotions
Paying Too Much Attention to the Financial Media
Chasing Performance
Thinking You Can Outsmart the Market
Ignoring Taxes
Disrespecting Inflation
Chapter 19: Ten Questions to Test Your Asset Allocation Know-How
What’s the Best Way to Get Consistently Good Investment Performance?
What’s Better: An 8 Percent Return or a 9 Percent Return?
What’s the Riskiest Kind of Portfolio?
How Much Variety Should You Include in the Asset Classes You Choose?
What’s the Best Way to Rebalance?
When Should You Rebalance Your Portfolio?
When Should You Revisit Your Asset Allocation Plan?
Should You Apply Your Asset Allocation Percentages to Each of Your Investment Accounts?
How Do You Know How Well Your Investments Have Performed?
Where Can You Go for Help with Your Asset Allocation?
Asset Allocation For Dummies®
by Jerry A. Miccolis, CFA®, CFP®, FCAS, MAAA
Brinton Eaton Wealth Advisors
and Dorianne R. Perrucci
Financial writer
Asset Allocation For Dummies®
Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com
Copyright © 2009 by Wiley Publishing, Inc., Indianapolis, Indiana
Published simultaneously in Canada
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About the Authors
Jerry A. Miccolis: Jerry’s clients, colleagues, and friends were caught a bit off-guard when, in 2003, he decided to change careers, from enterprise risk management to personal wealth management. But, toward the end of his 30-year stint in the actuarial and risk-management fields (including 25 years with the international management consulting firm Towers Perrin, where he eventually led the global enterprise risk management practice), he had already nearly achieved the two most sought-after certifications of his chosen second career — Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). He’s never been happier, helping real people secure their financial future. A senior financial advisor at, and co-owner of, Brinton Eaton Wealth Advisors in Madison, New Jersey, Jerry adds his CFA and CFP designations to his credentials as a fellow of the Casualty Actuarial Society (FCAS) and member of the American Academy of Actuaries (MAAA). Jerry, who is also a member of the Financial Planning Association (FPA) and the New York Society of Security Analysts (NYSSA), holds a BS in mathematics from Drexel University.
The coauthor of Enterprise Risk Management: Trends and Emerging Practices (The Institute of Internal Auditors Research Foundation) and Enterprise Risk Management: An Analytic Approach (Tillinghast-Towers Perrin), Jerry has chaired numerous professional committees and is a widely quoted author and speaker on the subject of strategic risk management, investment management, and their interrelationship. Jerry has been published in professional journals (Strategy & Leadership, Operational Risk, Risk Management, Institutional Investor, CFO Magazine, Investment Advisor, and Financial Planning) and in the mainstream media (The New York Times, The Wall Street Journal, The Baltimore Sun, MarketWatch, MSN Money, and Marketwire). He has appeared as an expert commentator on CBS Radio, ABC TV, and IRMI.com, the Web site of the International Risk Management Institute.
All of this, though, is what Jerry does between senior softball games, his real passion. There, Jerry plays third base and shortstop and bats much lower in the lineup than he thinks he should.
You can read more of his and his colleagues’ investment advice at www.brintoneaton.com (click Research Corner) and about his softball addiction at www.casact.org/newsletter/index.cfm?fa=viewart&id=5639.
Jerry A. Miccolis, CFA, CFP, FCAS, is a principal of Brinton Eaton Associates, Inc., d/b/a Brinton Eaton Wealth Advisors, an investment adviser registered with the United States Securities and Exchange Commission. No reader should assume that the book content serves as the receipt of, or a substitute for, personalized advice from Mr. Miccolis, from Brinton Eaton Associates, Inc., or from any other investment professional. Please remember that different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies referenced in this book) will be profitable.
Dorianne R. Perrucci: Dorianne jokes that she’s still looking for the 13¢ that caused her first checking account to bounce. Dorianne, who has written for Newsweek, The New York Times, Mediaweek, and TheStreet.com, began reporting about personal finance and investing in 1998 for Jane Bryant Quinn’s Washington Post column. Previously, she reported for a daily newspaper, wrote a political column for a U.S. senator, and produced articles and books for several of the country’s leading charities, including Covenant House, the Times Square shelter for homeless and runaway youth. She currently edits and collaborates on investing books, including: The Demise of the Dollar . . . and Why It’s Great for Your Investments, by Addison Wiggin (Wiley Publishing); I.O.U.S.A., One Nation, Under Stress, In Debt, with Addison Wiggin and Kate Incontrera (Wiley Publishing); The Ultimate Depression Survival Guide, by Martin D. Weiss (Wiley Publishing); and the AARP Crash Course in Creating Retirement Income, by Julie Jason (Sterling Publishing).
Dorianne, a graduate of Marquette University’s School of Journalism, is a member of the American Society of Journalists and Authors and the New York Financial Writers Association. When she isn’t busy explaining the consumer’s next investment challenge, she continues to search for that missing 13¢.
Dedication
To you, the average investor, who is curious enough to wonder if a For Dummies book can really help you get superior investment results, like the pros. Asset allocation, which begins with determining the right (and the right-size) baskets for your investment “eggs,” isn’t exactly a piece of cake, but we promise, if you’re determined to learn the recipe, we’ll make the process a very satisfying one for you.
Author’s Acknowledgments
It takes a village to write a book. Okay, not original, but true — you need a tribe of supporters to make it safely to the “efficient frontier” of investing.
Jerry Miccolis thanks his coauthor, Dorianne, for her contagious enthusiasm and offbeat sense of humor — and for constantly nagging him to “Keep it accessible!” Numerous editorial suggestions from his Brinton Eaton colleagues — Bob DiQuollo, Ben Jacoby, Jeremy Welther, Jerv Brinton, Nick Laverghetta, Ellen Clawans, and Abby Scandlen — vastly improved the final manuscript. Special mention to Marina Goodman, who seemed to take particular pleasure in offering blistering critiques of early drafts but also made excellent original contributions and helped prepare many of the exhibits and examples. They and the rest of the staff — Colleen Betzler, Dave Hill, Eric Mancini, Doris Merrick, Adrian Fedorkiw, Kim Dibenedetto, and Pam Trunfio — graciously picked up the slack for Jerry at the office. Most important, Jerry thanks Marcella, his wife and muse, for her unfailing support, encouragement, and understanding, during the nights and weekends he devoted to this book.
Dorianne Perrucci thanks Jerry, for his patience in explaining technical jargon and would like to ask him to explain perfect negative correlation one more time. She thanks her agent, Marilyn Allen, and the entire amazing For Dummies team, especially Acquisitions Editor Stacy Kennedy, who actually wanted to publish a book on asset allocation; Elizabeth Kuball, project editor extraordinaire; and Dummifier Brittain Phillips, whose mysterious ability to rework text works wonders. Dorianne is also grateful for her family and a host of colleagues and friends for continuing to cheer her on.
Publisher’s Acknowledgments
We’re proud of this book; please send us your comments through our online registration form located at http://dummies.custhelp.com. For other comments, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002.
Some of the people who helped bring this book to market include the following:
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Project Editor: Elizabeth Kuball
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Senior Editorial Manager: Jennifer Ehrlich
Editorial Supervisor and Reprint Editor: Carmen Krikorian
Editorial Assistants: Jennette ElNaggar, David Lutton
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Cartoons: Rich Tennant (www.the5thwave.com)
Composition Services
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Layout and Graphics: Carrie A. Cesavice, Reuben W. Davis, Melissa K. Smith, Christin Swinford
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Special Help: Brittain Phillips
Publishing and Editorial for Consumer Dummies
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Publishing for Technology Dummies
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Debbie Stailey, Director of Composition Services
Introduction
You don’t need to be an expert analyst, a star stock-picker, or a rocket scientist to have better investment results than most other investors. You just need to allocate your assets in the right way, and have the conviction to stick with that allocation. Talk about empowering!
The big secret behind asset allocation — the secret that most sophisticated investors know and use to their benefit — is that it’s really not all that hard to do.
If you follow asset allocation’s systematic, top-down approach to investing, you’ll be more likely to arrive at your financial destination safely, and with a lot more success and portfolio stability than if you try a bottom-up approach like the stock-pickers and market-timers employ (generally with lousy results). You’ll reach your long-term goals more reliably — and that’s a huge comfort during times of market volatility, when a charging bull market can turn overnight into a snarling bear market.
That’s not to say that sticking with asset allocation is the easiest thing in the world. It can be challenging, and it requires discipline, courage, and a little humility. At times, you’ll be bucking prevailing market trends and have to turn a deaf ear to pundits, friends, and family, who will think you’re nuts when you sell off your winners and buy losers to balance your portfolio. That’ll take some intestinal fortitude. Some of asset allocation’s key concepts can seem counterintuitive in other ways, too — but if you stick with the program, you’ll get more out of your money than you ever thought you could.
By following the asset allocation approach, you’ll
Help insulate your portfolio against market fluctuations, the overall economy, the effects of inflation, and more.
Make smarter decisions than the vast majority of individual investors out there — and do better than most of them over the long term.
Make fewer mistakes with your portfolio. Diversifying your investments, choosing assets that don’t always move up or down at the same time, and rebalancing your portfolio opportunistically will make it harder for you to stumble.
In short, you’ll be a winner in the only monetary game that counts — enabling your life’s dreams by protecting your financial future.
About This Book
There are several books about asset allocation out there, most of which are written for investment experts. This isn’t one of those books. Sure, Jerry is a wealth-management expert with tons of asset allocation experience and Dorianne is a financial journalist, but we pride ourselves on our love for explaining the mysteries of investing to average investors like you. In this book, we make the often overly technical information about asset allocation accessible, whether you’re a beginner or you have a little investing experience under your belt. We had fun writing this book together, and we hope you have fun reading it and using its contents to help you reach your financial goals.
One of the ways that we make the information contained in this book easier for a beginning investor to digest is the use of plenty of charts and tables. When you encounter these helpful tools, take a moment to size them up. You’ll be rewarded, and you may be surprised by how much information you pick up right away. These illustrations just may be the handle you need to get a nice, firm grip on asset allocation.
Conventions Used in This Book
To help you navigate your way through this book, we use the following conventions:
We use italics when we define new terms that probably aren’t familiar to you.
We use monofont for Web addresses. Some Web addresses may need to break across two lines of text. If that happened when the book was printed, just type in exactly what you see in this book — we didn’t add any extra characters (such as hyphens).
We discuss several different types of investment returns throughout this book, and what they mean for you. But when we use the word return without further modification, we’re referring to total nominal return, which combines income and growth unadjusted for inflation. (You can read all the details in Chapter 2.)
What You’re Not to Read
This book is a reference, which means you don’t have to read it from beginning to end (any more than you have to read a dictionary from beginning to end to get what you need from it). If you’re in a hurry, you can even skip certain pieces of information and still get the gist of what you need. Here’s what you can safely skip:
Anything marked with a Technical Stuff icon: For more on this icon, see the “Icons Used in This Book” section, later in this Introduction.
Text in gray boxes, which are known as sidebars: Sidebars contain interesting — but not essential — information.
The copyright page: Sure, the publisher’s attorneys’ feelings will be hurt, but you can skip the fine print without losing out on anything important. Shh! We won’t tell.
Foolish Assumptions
When we began writing this book, we started with a few assumptions about you, our esteemed reader:
You have a good idea of what you want to accomplish financially, but you don’t know exactly how to get there.
You’ve done a bit of investing, but not a lot, and you’d like to benefit from what the experts know about asset allocation.
You know there has to be a better, more reliable, route to investment success than listening to all the talking heads in the financial media or chasing the latest hot stock tip.
You’re wondering if it’s possible for anyone to make this stuff easier to understand — or even fun.
How This Book Is Organized
This book discusses asset allocation in what we believe is a natural, logical order. You can read the chapters that way, if you want. But this also a true For Dummies book, so feel free to bounce around and read a little here and a little there, depending on what you’re interested in and what you want to understand first.
Part I: Discovering the Not-So-Secret Recipe for Asset Allocation
In Part I, we lay out the basics behind the asset allocation recipe, which begins with diversifying the assets you choose for your portfolio. But diversification isn’t all there is to asset allocation. In order for you to figure out your ideal asset allocation, you need to assess the level of risk you’re comfortable taking in exchange for the return you’re seeking. In other words, how much are you looking to make, and how much risk are you willing to take on?
We also look at the many types of asset classes you can choose, ranging from standard choices (cash, fixed income, equities) to alternative choices (such as real estate and commodities). After you’ve got a grip on the various types of asset classes, then you’re ready to make some specific choices like stocks, bonds, mutual funds, exchange-traded funds, and the like.
We tell you how you can avoid costly mistakes, and protect your portfolio from volatility, by choosing investments that don’t always move up or down at the same time. Finally, we fill you in on portfolio rebalancing, which is overlooked by most investors but embraced by the pros, who know it can be used to control risk and generate extra return.
Part II: Getting Started
You need to nail down your own personal investment strategy, and in this part we walk you through an exercise that helps to define your parameters. Those parameters include your investment horizon, risk tolerance, portfolio constraints (for example, for religious or personal reasons, you may not want to buy stocks that invest in alcohol or gambling), tax situation, and special circumstances, such as protecting your assets from creditors or your estate from taxes.
Then you’re ready to develop your investment strategy and figure out what you need to sustain your lifetime cash flow. We know it sounds like a lot of big decisions, but we break it all down for you. If you’re going to need $50,000 a year (in today’s dollars), starting in five years, and you have $350,000 now, how are you going to get from here to there? Do you know your current assets and liabilities? Your current and future sources of income and expenses? And finally, how do you tie all this information together in a meaningful and useful framework, leading to the asset allocation that’s just right for you? We answer those questions, and many more, in this part. We also give a kick-start to establishing your own unique asset allocation by looking at some valuable sample allocations.
Part III: Building and Maintaining Your Portfolio
This part shows you how to fill your asset allocation baskets with specific investments of various types. Wondering what specific investments you should buy? We tell you. Don’t know how to buy those specific investments? We fill you in. Worried about the many types of fees and expenses that can creep up on you? We let you know how and where to look for them.
Because most investors have several accounts (one or more taxable accounts, individual retirement accounts for husband and wife, and so on), we also match the right investments with the right accounts, to exploit the tax characteristics of the different accounts and avoid creating unnecessary tax bites. Then we get into the details of portfolio rebalancing (introduced in Part I) so you can get extra return if you rebalance faithfully. Finally, we explain how to measure your results and compare your portfolio’s performance with the appropriate external benchmarks, so you know how well you’re doing.
Part IV: Going beyond the Basics
In this part, we take a close look at alternative investments (real estate and commodities, for example) and the wonderful things they can do for your portfolio. Then we point out how you can gain the kind of tax knowledge that’ll help you keep more of your well-deserved gains. After all, there’s no sense in giving away too much of your money in taxes when it can be avoided with some savvy planning. We also identify the situations that should prompt you to revisit — and validate or revise — your long-term asset allocation plan.
If you need help figuring out some (or all) of the asset allocation process, we help you look over the choices of financial advisors available, and tell you the importance of paying attention to their credentials. (Hint: Some of those credentials are meaningless and/or misleading!) We also discuss how much these experts get paid — and by whom — and how to make sure they’re working in your best interests, not their own.
Part V: The Part of Tens
If you like top-ten lists, this part is for you! The three chapters in this part help you jump-start your asset allocation with easy-to-digest (and interesting) information. Our list of ten important asset classes with their historical rates of return is a valuable reference you can use on its own, or as a tool to come back to time and again as you read other chapters. We also point out ten common mistakes that prevent investors from becoming good asset allocators. When it comes to bang for your buck, this part scores, well, a perfect ten.
Icons Used in This Book
Throughout this book, we use icons (little pictures in the margin) to draw your attention to certain kinds of information. Here’s what the icons mean:
When you see a Tip icon, read it to find a nugget of asset allocation wisdom that you can apply as you carry out your investing strategy.
Anything flagged with a Remember icon is especially important to your understanding of one of asset allocation’s many facets. This is the stuff you don’t want to forget.
The Warning icon flags a potential problem or pitfall that could give you fits if you weren’t aware of it. If you’re into dodging bullets, stay on the lookout for Warning icons.
The Technical Stuff icon appears next to material that can be a bit tricky. You may not be able to pick up on it right away, and it may not be absolutely critical to your understanding of the topic being explained, but if you can manage to tackle the information, it’ll give you an even firmer grasp of asset allocation . . . or at least impress your friends.
Where to Go from Here
You can tackle this book in several ways. If you’re a beginner, you may want to read Chapter 1 to get the big picture, and then scan through the beginnings of the other chapters to find the inroad that interests you the most. If you really want to know what makes asset allocation such a great strategy, check out the chapters in Part I. There you’ll find some of the background material that’ll help you to understand why asset allocation makes so much sense. Or maybe you’ve heard a little bit about all the different types of assets out there, but you want to read a lot more. If that’s the case, flip to Part III. There you can find out what’s on offer and what makes the most sense for your portfolio.
If you’ve already wrapped your brain around investment and asset allocation basics, it may be time for you to turn to Part IV, where we discuss a few more-advanced topics like alternative investments and tax strategies. This part also includes a very helpful chapter that tells you how to find the best financial advisor for you.
No matter where you start, don’t feel compelled to read this book straight through, from beginning to end. We wrote the book so you could start anywhere, and we provide lots of cross-references to point you to other places in the book where you can find information you may need to better understand what we’re talking about. Whichever way makes sense to you — dig in, you (and your portfolio) will reap the rewards!
Part I
Discovering the Not-So-Secret Recipe for Asset Allocation
In this part . . .
We start by looking at the big picture of asset allocation — from what seems like 30,000 feet. But as we talk about risk and return, and review the various asset classes and how to mix them together in the right proportions, you begin to focus in and see how getting that mix right is the single most important investment decision you can make. We also introduce portfolio rebalancing, which is a process overlooked by most investors but championed by the pros, to control risk and generate extra return.
Chapter 1
Understanding Asset Allocation
In This Chapter
Appreciating the importance of asset allocation
Discovering how to apply asset allocation to your portfolio
Getting started with building your portfolio
Going beyond the basics to get the most out of asset allocation
Psst! Want to know the trick to making a killing in investments? One that offers fat financial returns with little or no risk? Sadly (and as you’d probably guess), there’s no such thing.
Want to know how you can score great long-term investment results while minimizing unnecessary risk and costs? In that case, you’ve come to the right place! With the right asset allocation, you can enjoy substantial investment returns with the lowest possible amounts of risk and cost.
Asset allocation, in simplest terms, is deciding how to divvy up your investment dollars among various types of assets. More fully, it’s a comprehensive, coherent, top-down, strategic approach to investing that has well-established science and years of real-life superior investment results to back it up. In other words, it’s bona fide, and when it comes to investing, nothing consistently beats it.
In this chapter (and throughout this book), we show you how and why asset allocation works and, perhaps more important, how it can work for you. We take you step by step through the time-tested approach to investing that the most successful professionals use. We explain how you can reap the benefits of rebalancing, which is the closest thing to a free lunch you’ll ever find in investing. And we show you how to do all this and save on your taxes, too!
In true For Dummies fashion, Chapter 1 is a microcosm of the book that follows. Think of this chapter as a bird’s-eye view of asset allocation. We hit all the high points, and, as we go, we point you to the chapters you can visit to get a more detailed treatment of each topic.
Figuring Out Why Asset Allocation Is So Important
When it comes to your investments, what’s more important than asset allocation? In our opinion — and in the opinion of most every reputable investment expert — nothing.
In this section, we clue you in on why asset allocation is so important, using a couple different perspectives. First, we use the infamous story of Enron to show you the terrific power of diversification, which is one of several fundamental aspects of asset allocation. Then, to give you a feel for asset allocation’s other key aspects, we use the rest of the section to take a broader view, exploring what independent studies have to say about the role of asset allocation in driving investment success.
Encapsulating the Enron story
Here’s the short version of the Enron story: Beginning in the early 1930s as a modest oil pipeline company, Enron grew over the years, through mergers and acquisitions of other energy companies. By the late 1990s, it was very aggressive in energy trading and other complicated financial engineering ventures. (Don’t worry about the details — it was really, really complex stuff.) Enron had, in fact, become an industry leader and business-school case study in the creative use of these sophisticated financial arrangements. By early 2001, Enron had grown to be the seventh largest company in the United States based on revenue and had been named America’s Most Innovative Company for the sixth year in a row by Fortune magazine. It was also on Fortune’s 100 Best Companies to Work for in America list in 2000.
Then the bottom fell out. Before the end of 2001, Enron was bankrupt. The cause was accounting fraud. The lengths to which Enron’s executives went to conceal their illegal activities were epic in their ingenuity and complexity. That’s the white-collar-crime part of the story that was splashed all over news headlines for months. But that’s not the worst part.
The worst part — and the part most relevant to you, the average investor — was this: Even while the Enron executives were perpetrating their fraud, they were encouraging their own employees to stake their financial futures on the company. In addition to offering an employee stock ownership plan (ESOP), Enron urged its employees to invest in company stock in their retirement plans. The company’s matching contributions to its employees’ 401(k) plans were made exclusively in Enron stock. And, in the fall of 2001, as its fraudulent financials were unraveling, Enron made it impossible for its employees to switch out of Enron stock in their retirement plans.
It was a real tragedy for thousands of Enron employees, who watched helplessly as their retirement funds and personal financial futures evaporated. Sadly, it happened because Enron led them to violate one of the immutable laws of sound investing: Never, ever put too many of your eggs in one basket.
Keep your investments diversified! Don’t invest too much in any one security, especially your employer’s stock. (Enough of your financial future is already tied to the company’s well being.) As a general rule, don’t invest more than 5 percent of your invested assets in any one stock.
So that’s the enduring lesson of Enron for investors: Diversify, diversify, diversify! Asset allocation begins with portfolio diversification, but as we describe later, it goes much further.
Exploiting the 90 percent solution
Quick — what decision will have the biggest impact on your investment results? It’s not stock picking (chasing so-called “hot” tips on individual securities, usually without regard to a coherent portfolio strategy) or market timing (trying to beat the market by timing when to get in and get out of it). The lion’s share of your performance will be determined by your asset allocation — how you divide your money among various types of assets.
According to several well-regarded academic studies over the years, over 90 percent of the difference in returns among various investment portfolios is explained by one thing: asset allocation. That fact alone should lead you to a profound revelation: You should spend the vast majority of your investing time and effort on getting your asset allocation right. Nothing else matters nearly as much.
Separately, study after study has shown that investors who take other approaches, such as market timing or stock picking, consistently underperform the market averages over the long term.
But if those types of dubious investment strategies have been shown to fizzle out in the long term, why do you see so much newsprint and radio and TV airtime devoted to them? Why are most of the stories about market timing and stock picking instead of asset allocation? Because those other things are sexy. They’re exciting. And they play to our baser instincts — our desire to jump into the next great low-effort, get-rich-quick scheme. By contrast, asset allocation is a steady and reliable approach that takes some thought and consideration. In other words, it’s relatively unexciting. But it’s the investing approach the pros have used for decades to get better long-term results than those other guys. (Check out the “Appreciating the science of asset allocation” sidebar in this chapter to find out why.) Asset allocation gives you a much better chance of ending up with more money in the long run. How’s that for unexciting?
Appreciating the science of asset allocation
Sometimes, asset allocation and its associated activities seem counterintuitive. It may make you uncomfortable, particularly when those around you are doing the opposite of what you’re doing (buying when you’re selling, selling when you’re buying, avoiding investments you’re embracing, and so on). At those times, reassure yourself with some knowledge of the science behind what makes asset allocation work.
One of the principles of asset allocation is the reduction of portfolio volatility. Excessive volatility can cost you real dollars because of a phenomenon called risk drag. As we explain in Chapter 2, risk drag eats away at your investment return over time. By combining the right investments in the right proportions, you can tame risk drag.
Finding those investments and determining those proportions is also a matter of some science. The trick is to find investments that don’t correlate very well with each other (meaning, they don’t all go up or down at the same time). Investments like that may seem unappealing to new investors, but those in the know realize that they can use them to create real portfolio magic, as we show you in Chapter 4.
And here’s the best news of all: You don’t have to be a financial genius or fork over a huge wad of cash to a world-class broker or an elite hedge-fund manager to reap the rewards of asset allocation. You just need to understand the basics and figure out how to apply those basics to your personal investment situation.
The rest of this chapter shows you how to do just that.
Uncovering the Basics of Asset Allocation
Successful asset allocation involves a few basic concepts. These main components, which form the centerpiece of Part I, are as follows:
Understanding the fundamental relationship and trade-off between investment risk and return
Selecting the asset classes that are right for you
Determining the right mix of those asset classes to achieve your objectives
Rebalancing your portfolio periodically to maintain your desired mix
We take you step by step through these basics in this section.
The complete asset allocation picture contains other less basic features (developing your investment strategy in the context of your long-term financial plan, filling your portfolio with the right securities, putting those securities into the right accounts to get the best after-tax results, measuring your performance, and so on), which we cover a little later in this chapter.
Balancing risk and return
Risk and return are the two central concepts underlying all of investing. To enjoy a return on your investments, you have to take some risk. Although return (your percentage gain) can be measured with objective precision, risk is a very personal, subjective concept. Whether you define your own concept of risk as uncertainty, instability, the chance of losing money, lack of peace of mind, or in some other manner, one thing is generally true: The more return you want, the more risk you have to accept. As you consider the length of time over which you’ll be investing, your ideas about risk and return may change in surprising ways. You can read all about these concepts, including the all-important trade-off between risk and return, in Chapter 2.
The risk-return trade-off has been the subject of much academic study. One of the really useful tools that has emerged from all that study is the efficient frontier. It might sound a little cold and complicated, but it’s really a simple visual device that’ll help you reach a deep understanding of asset allocation’s core concepts and guide you toward the asset allocation that’s right for you. We show you how to use the efficient frontier in Chapter 2.
Selecting your asset classes
An early step in asset allocation is determining the asset classes (groups of investments with similar characteristics) that you want in your portfolio. In Chapter 3, we take you on a tour of the asset classes at your disposal. There are traditional classes, such as cash, fixed-income investments (including bonds and bond funds), and equities (including stocks and stock funds). We cover issues such as maturity, creditworthiness, and taxability of the various types of fixed-income investments, as well as the size, style, and sector of your equity investment choices.
We also dig into so-called alternative investments, which can help stabilize your portfolio. These include real estate, hard assets (such as commodities), and hedge funds. And we discuss going global with international investments in all these areas.
Many of the asset classes you can invest in may have unique and important roles to play in your portfolio, so it’s wise for you to get to know them as well as you can.
Determining your asset mix
In addition to knowing what kinds of assets are available for you to include in your portfolio, you also need to understand how to mix those assets in the right proportions.
To best appreciate how the right mix works for you, and to help you find your ideal mix, you really need to understand correlation (the way your various asset classes behave in relation to each other). We can’t stress the importance of correlation enough, and you can dive into the details in Chapter 4.
The holy grail of investing is a set of asset classes that have perfect negative correlation with each other, meaning that one zigs when the other zags (that is, if one moves up, the other moves down by the same amount, at the same time). Asset classes like that can be combined to create a portfolio that has absolutely no risk! But, as you may imagine, perfect negative correlation — like perfection of any kind — is impossible to find in real life (with the exception of chocolate peanut butter ice cream), so you try to get as close as you can. You can reduce risk drag (see Chapter 2) considerably, and thereby improve your portfolio’s return, just by properly mixing assets that have positive, but weak, correlation. In Chapter 4, we show you how to let these ideas guide your decisions on asset mix.
In determining how much of an asset class to include in your portfolio, keep in mind that the characteristics and behavior of any one asset class on its own are irrelevant. What really counts is the behavior of the entire portfolio when that asset class is added to it. This is a guiding principle of asset allocation. (We cover how to put this principle to practical use in Chapter 8.)
Rebalancing your asset mix
Setting up your asset mix isn’t the end of asset allocation. The financial markets, where investors buy and sell securities, will see to it that different asset classes inside your portfolio will grow at different rates. Over time, your portfolio will, therefore, drift away from the mix you set up so carefully. When that happens, you’ll need to occasionally buy and sell assets to get your portfolio back to your target allocation. That process is called rebalancing.
Rebalancing on the right schedule will do more than keep your portfolio faithful to its asset allocation. It’ll help you rein in risk. More surprisingly, it’ll also help you generate extra return seemingly out of thin air! That’s what we mean when we say that rebalancing is the closest thing to a free lunch you’ll ever find in investing.
Rebalancing sounds great, right? It really is, and you can read up on the details in Chapter 5. Rebalancing forces you to buy low and sell high. It allows you to exploit a phenomenon called volatility pumping to get you that extra return. But you have to have the fortitude to do it correctly, because it’ll require you to do things at times that are contrary to what others around you who haven’t read up on asset allocation are doing. But the payoff is worth it: Rebalancing will reduce your risk and ramp up your long-term returns.
Getting Started with Your Investment Strategy
As you can read in the previous section, Part I of this book is all about understanding the basic tenets of asset allocation. That’s crucial stuff, and it’s tough to do much with asset allocation if you don’t have a grasp on the basics. But when you’ve wrapped your brain around them, how do you make those basics work for you? The next step is developing a well-considered investment strategy, and that’s what you can discover in Part II.
As we outline in Chapter 6, your strategy should lay out the following parameters:
Your investment horizon: This is the length of time you expect to be invested. It’s critically important to get this right, and here’s a big clue: It may be longer than you think.
Your return objectives: This isn’t the return you want, but the return you need. We help you determine your return objectives when we discuss your long-term financial plan, later in this section.
Your risk tolerance: However you define your subjective concept of risk, there’s likely a point — a limit — beyond which you’re just not comfortable going. We show you how to use this tolerance level to find your best-performing asset allocation.
Your portfolio constraints: You may have certain investments, or even whole asset classes, that you just won’t consider for personal reasons (for example, maybe you won’t invest in a tobacco company because your father died of lung cancer, or you won’t invest in a beer company because drinking is against your religious beliefs) or certain holdings that you just won’t let go of (maybe you just can’t bring yourself to sell the stock your grandma left to you). We explain how to deal with these limitations.
Your tax situation: Your tax bracket may lead you to consider certain asset classes that wouldn’t make sense for you otherwise. We discuss how you can exploit this situation.
Your special circumstances: If you have an unusual exposure to lawsuits (due to your profession, perhaps) or an overriding desire to protect your assets from estate taxes, we describe how you might make certain adjustments to your portfolio.
You should set these investment strategy parameters after looking at your long-term financial plan. We show how to do that in Chapter 7, where we introduce another useful tool, your Lifetime Cash-flow Projection (LCP). We’re not going to lie: Developing your LCP is the most work we ask you to do in this book. Compared to some of the other tasks, it can feel like heavy lifting. You don’t have to do it if you don’t want. We’re not saying you can’t get yourself a decent asset allocation without an LCP, but we really don’t think you should cut corners when it comes to your financial future. In addition to helping you derive the asset allocation that’s just right for you, your LCP also allows you to test any number of critical “what if” scenarios as you go through life. We also advise you to document your investment in an Investment Policy Statement, just as the pros do.
Speaking of the pros, in Chapter 8, we show you how they would use all this information to derive an ideal asset allocation for you. We show you what you can learn from them to do it yourself. We also give you a head start by showing some sample asset allocations and taking you step by step through an example with a fictional couple, John and Jane Doe.
Building Your Portfolio and Keeping It True to Your Long-Term Goal
After you’ve settled on your asset allocation (you’ve assigned target percentages to all the asset classes you want in your portfolio), then what do you do? That’s when it’s time to do some shopping. You have to buy securities to put in your portfolio to achieve the allocation you decided on. When you do that, you have to figure out in which of your various investment accounts to buy the securities. (You keep your securities in accounts, and determining which accounts should hold which securities is an important process.)
But if you’re smart, you won’t stop there. You’ll diligently monitor your portfolio, so that, among other things, you’ll know when you need to rebalance. And finally, you’ll want to measure your portfolio’s results in a meaningful way to gauge whether all this is working the way you want. We cover all these things, in turn, in this section and throughout Part III.
Selecting securities
Within each of the asset classes we outline in Chapter 3, there are scads of securities you can buy to represent the asset class. With thousands of possibilities, how do you choose? In Chapter 9, we take you on a tour of the securities available to you. There are stocks and bonds, of course. There are also mutual funds and exchange-traded funds, and we explain why we generally prefer the latter over the former. We also discuss index funds and actively managed funds, annuities, options, structured notes, exchange-traded notes, and others.
To keep your asset allocation in ship shape, you’ll want to buy different securities in different circumstances. Sounds logical enough, but what’s the best way for you to actually buy securities? You have a couple of broad choices: You can buy them on your own or buy them through a broker. There are advantages and disadvantages to each approach, and we cover all the relevant information in Chapter 9. You can also, if you dare, use shorting and/or leverage to expand your opportunities. We’re not crazy about the prospects of those techniques for new investors, but we know you’ll hear about them as you continue to grow as an investor, so we fill you in on the details.
Any security you buy carries a cost. Some of those costs — like trading commissions — are explicit; others — 401(k) management fees, for example — aren’t. Some can be quite large. We provide a very complete catalog of fees and expenses that you may encounter and tell you how to uncover and compare them.
Mastering asset location
That’s right — we said “location,” not “allocation.” Asset location is the tactic of matching your securities with your accounts in an optimal way to exploit all the tax advantages you can. If you choose the location of your assets wisely, you can save a bundle in taxes. (Flip to Chapter 10 to read more.)
Throughout the book, we advise you to do your asset allocation on a holistic basis (that is, across all your investment accounts in the aggregate). Those accounts may include an individual taxable account for you and, if you’re married, one for your spouse. Maybe the two of you have a joint account or two. And then there are IRAs, 401(k)s, health savings accounts, and more. When you really sit down and think about it, you may be surprised by just how many accounts you have. You should consider them all in total when you apply your asset allocation.
That doesn’t mean that you apply the same allocation percentages to each of the accounts — quite the contrary. The reason? Taxes. Each of the securities you may want to buy has its own income-tax characteristics, and some are more tax-friendly than others. And each of the accounts you own has specific tax features. Some are fully taxable, some are tax deferred, and some may be tax free. You can save a lot of taxes by being clever about which securities you locate in which accounts. In Chapter 10, we take you through a detailed example, using the Does (a fictional couple we introduce in Chapter 8), to show you how to be tax smart at the account level while achieving your desired asset allocation at the portfolio level.
Monitoring your portfolio to stay on target
The rebalancing that we talk about earlier (and in depth in Chapter 5) can provide you substantial benefits. (Remember that rebalancing is what we call the closest thing to a free lunch you’ll ever find in investing.) But to get those benefits, you have to rebalance at the right times.
The “right time” to rebalance can’t be scheduled in advance. These times aren’t specific calendar dates; they occur when your portfolio drifts away from its target asset allocations by a sufficient amount. So, you need to keep tabs on your portfolio to make sure you don’t miss those rebalancing opportunities.
In Chapter 11, we go through this rebalancing exercise with the Does. As we also discuss in that chapter, there are additional reasons to diligently monitor your portfolio. The individual securities you own may suddenly go sour and start losing value. Or, after a good run, they may simply run out of steam. When you add a security to your portfolio, you should set guidelines around its market price. Those guideline prices will act as useful triggers, to let you know when you should review the security and possibly remove it from your portfolio.
You also want to monitor your portfolio to be on top of opportunities to take advantage of certain tax-saving tactics, such as tax loss harvesting, which we discuss in more detail in the “Tackling taxes” section, later in this chapter.
Measuring your results
You may have heard the old saw “You can’t manage what you can’t measure.” When it comes to investing, that nugget is a golden one. So it’s certainly worth knowing how to measure your investment results the right way.
In Chapter 12, we outline the following five key elements for understanding your investment results and putting them in meaningful context:
Principal: The amount you invested
Term: The length of time over which you’re measuring your results
Risk: The degree of safety built into your investment
Opportunity cost: The results you could’ve gotten for a typical alternative investment with similar risk over the same term
Suitability: The degree to which this investment is in step with your financial plan
We show you how to express your results as a return, to address the first two elements — principal and term. Then, to cover the next two elements — risk and opportunity cost — we explain how to derive, and compare your return against, relevant benchmarks. Finally, we revisit your LCP, which we discuss earlier in this chapter and in Chapter 7, to help you determine the suitability of your investment and to track future progress.
Reaching Past the Asset Allocation Basics
