There's a lot of simplistic advice out there about allocating your assets. For example, subtract your age from 100, and that's the portion you should have in equities. Put the rest into bonds and cash.
That's not particularly helpful advice these days, and I'm not sure it ever had been.
With U.S. life expectancy increasing all the time, there are many cases in which it literally pays to be a more aggressive investor at you age. Likewise, if you have a pension or other income that covers your living expenses, you can also afford to be less conservative in your portfolio.
In addition, that old advice doesn't give you any clue about breaking down your investments within the broader asset classes of stocks and bonds. Domestic large-caps or emerging market small-caps? Investment grade corporate bonds, Treasuries or high-yield? Long-term or short-term bonds?
While asset allocation isn't particularly difficult, it does require some thoughtful planning. By planning, I mean figuring out the expenses you'll need to maintain your lifestyle, figuring out what kind of income you can realistically expect to receive from all the various sources available to you, and finally, figuring out what kind of portfolio design you require to get the necessary return.
Diversification, of course, is the key to allocation. Diversification is the basis for determining which asset classes will reduce your risk while giving you the best probability of getting your return.
One way to go about allocating is strategically. You typically pick some indexed equity mutual funds or ETFs, as well as some bond funds tracking large, popular indexes. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) is a popular holding in strategically allocated portfolios. By understanding the historical return for an allocation with that risk level, and through regular rebalancing, you can make fairly good forecasts on what to expect over the course of your investing life.
In contrast, tactical allocation is favored by traders and others who believe they have the skill to regularly beat markets. Usually, investors choose the S&P 500 as a market to beat, then load up on riskier small-caps, which, of course, will beat large-caps over time.
With tactical allocation, you aren't trying to buy the entire market, or even specific asset classes that you believe will outperform.
I'm going to be frank about problems I see in many of the portfolios that new clients bring to me. Often, there was an attempt at tactical allocation of some sort, but it fizzled and ended up with just a willy-nilly batch of stocks, ETFs, mutual funds and cash, allocated in no cohesive way.
Other times, a person was actively - very actively - managing a portfolio, but the holdings were based on whatever the person thought will be hot. If the market turns down, even slightly, there is frequently panic selling. I saw that quite a bit in September of this year.
Be aware of the emotion-based decisions you might be making. That's a problem, too, because a lot of traders and investors couch their emotional decisions as "logical," when nothing could be further from the truth.
In my next column, I'll continue with some thoughts about better ways to allocate your portfolio.