When I started in the business in 1991, one of the biggest fundamental teachings was the concept of asset allocation. Asset allocation is all about the notion that different assets classes offer returns that are not perfectly correlated, hence diversification reduces the overall risk in terms of the variability of returns for a given level of expected return. (www.wikipedia.com) Today’s world of asset allocation uses these fancy pie charts that show clients cash, corporate bonds, international bonds, government bonds, large cap stock, mid cap stock, small cap stock, international stock, emerging markets, commodities, real estate, and many more different types of asset classes. The idea of all of these assets classes are supposed to act and look a lot like magnets. By having a balance of these asset classes, while some areas have worse years other categories will have better years minimizing the overall risk.
Even though we have the most college educated adults in the history of the United States, very few people get a real course in personal finance. Thus, even the smartest of these people could hardly tell you much about asset allocation at all. Could 1 out of 10 people clearly define by actual numbers what a large cap stock actually is in terms of market capitalization? Could a basic investor tell you five different emerging markets? Heck, many of them can’t even clearly articulate how a bond instrument actually works. So, how can we give a different thought process about asset management to the next couple of generations as asset allocation may continue to give them a glazed look in their eyes when it comes to how to manage their retirement assets? Here is a your smart money moves philosophy when it comes to an easy way to think about how to bucket your asset management by using the SIGN philosophy.
S- SECURITY – The first area of your asset allocation is determined by how much money you need to keep in the security bucket. In the good old days, the secure bucket was largely determined by what the corporation would provide you for a pension when you retired. As many of us realize today, companies hardly offer that type of benefit anymore. Consequently, we need to figure out how much of our personal SIGN needs to be guaranteed, fixed, and secure. These are the type of assets where you attempt to take our things like market risk and interest rate risk. It is possible to create your personal pension plan.
I- INCOME – The second area of your asset allocation is going to be determined by how much money you need to keep in the income bucket. There are various type of income producing assets, some fixed and some variable. In the fixed income arena, we are talking about municipal bonds, U.S. Government bonds, Corporate Bonds, C.D.’s, Treasury Inflation Protected Securities, and savings bonds. This isn’t an end all and be all list, but what you are attempting to get at is what type of overall interest rate do you expect to get in return for loaning out your money. This bucket should be left largely for loanership type dollars instead of ownership type dollars. While there are equity investments such as dividend paying stocks and real estate, this new type of thought process reserves this bucket for fixed income type investing. We would normally expect some level of income to come from social security, but as many Gen X and Gen Y investors know social security may not be there for us.
G- GROWTH – The third area of your asset allocation is going to be determined by how much money you need to keep in the growth bucket. The growth bucket is designed for ownership type dollars. Specifically, having money in assets such as stocks, precious metals, real estate, and other categories where you are putting dollars at risk for the potential for larger future growth. Growth investing can happen in all types of accounts including 401k’s, IRA’s, Roth IRA’s, and brokerage accounts. Depending on your personal SIGN, growth investing may be a larger or smaller part of the equation.
N- NEED – The final piece to the SIGN philosophy is to determine your overall need to get to your goals. This is true whether we are talking about buying a first home, planning for children’s college education, or thinking longer term about our exit plan to make work optional. You have to calculate how much you will need to determine the right balance of Security, Income, and Growth as you figure out how to reach your needs.
One study suggests that more than 91.5% of a portfolio’s return is attributable to its mix of asset classes.(www.cfainstitute.org) When it comes to planning your portfolio for the X and Y generation, asset allocation has become an overwhelming process and really needs to be simplified. If you can more reasonably think about how much you need in security, income, and growth as you plan your needs it will allow you to become more clear on what you are doing with your money. Make a smart money move and rethink how you do your asset allocation in 2013!
CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Editor in Chief of Your Smart Money Moves
Co-CEO and Founder of oXYGen Financial, Inc – The Leaders in Gen X & Y Financial Advice and Services
Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice to the X and Y Generation.
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