Asset Allocation Guidance

The importance of asset allocation can’t be ignored. Obviously there is not just one correct approach. Your asset allocation model might be very different from my example.

The goal is to implement asset allocation strategies that lower your overall portfolio volatility. While it may be more fun to pick individual investments, your asset allocation decisions will have the largest effect on your long term returns.

I have 5 pieces of guidance for your asset allocation plan .

1. Have Patience and a Long Term Horizon

In our fast paced world, with internet trading and instant gratification, it is popular to look for quick returns through schemes and strategies that carry undue risk. Benjamin Graham and Warren Buffett have taught the virtue of patience and the willingness to hold investments for long periods of time.

The markets will not always recognize the value in an investment immediately after your purchase. Sometimes patience, time, and a longer term horizon are required before your investment is ready to harvest.

2. Take Advantage of Mis-priced Markets

Graham used the parable of Mr. Market to illustrate the fact that investments are often mis-priced, sometimes overvalued, and other times undervalued. It makes sense to capitalize on mis-priced investments in order to increase your probability of making a profitable investment.

Valuation Analysis is the discipline of weighting your asset allocation based on valuation. Asset categories which are expensive should be avoided or underweighted, and categories that are bargains may deserve an overweighting.

3. Require a Margin of Safety

The core concept of margin of safety is: price matters! The lower the price you pay, compared to the real value of the investment, the greater the probability that your investment will be profitable.

Purchasing investments at a deep discount reduces the risk of owning that asset. The margin of safety allows for problems, mistakes, or unforeseen disasters. Negative surprises may have less impact on an asset that is already priced low.

At the same time there is more upside to investments bought at a large discount to its real or intrinsic value. As time passes, eventually the market should realize the true value of the investment, and provide a sales price closer to that value. The larger the margin of safety the higher your probability of above average returns.

4. Rebalance Your Portfolio (Often)

Portfolio rebalancing is a risk management strategy in which you buy or sell investments to achieve your desired asset allocation percentage. As asset prices increase or decrease the total value will depart from your desired asset allocation target.

Portfolio rebalancing helps an investor to buy low and sell high. This is because the strategy involves achieving your target asset allocation by selling a portion of the assets that have risen in price and buying more of the assets that have fallen in price.

5. Preserve Your Capital

Preservation of Capital should be an investors highest priority. Warren Buffett famously said “Rule # 1: Never Lose Money; Rule # 2: Never forget Rule #1.”

Related Reading: Portfolio Risk Control Strategies – Focus On What You Can Control

To be a successful investor you need to understand how compounding works for you and against you. If you lose 50% and gain 50%, you still have a 25% loss! These rules of mathematics make capital preservation extremely important.