Where to Put Your Money: The Basics

December 22, 2010, By Tyler Newton 0 comments

“Asset allocation” may sound like the kind of term used by rich money managers and Ivy League university endowments. In fact, anyone with a savings account, a 401(k), a pension plan or real estate should be thinking about asset allocation. “Asset allocation” is just a fancy way of saying “don’t put all your eggs in one basket." By putting your money in several different baskets, you can reduce risk and potentially increase returns by diversifying your investments.

Establish a target allocation. There are three general baskets of investment assets. A decent goal would be a have a third of your assets in each.

• Fixed income (cash and bonds) provide interest income over fixed maturities. Fixed income investments perform best when inflation is low or negative. They also do best during recessions. Social Security, corporate pensions and annuities should also be viewed as fixed income investments.
• Stocks are ownership positions in companies. They can provide both dividend income and capital appreciation. Stocks perform best during periods of low-to-moderate or falling inflation. They also do best when coming out of recessions or during the middle of economic expansions. Employer stock options and ownership in a family business should also be viewed as stocks.
• Real assets are investments in tangible assets like a house, investment real estate, precious metals, timberland, commodities and even art, jewelry, antiques and collectibles. Real assets may provide rental income, but are often expected to offer price appreciation due to inflation. Real assets tend to do best during periods of moderate-to-high or rising inflation. Real assets also tend to perform best late in an economic expansion.

Adjust for career risk. Is the risk of my career more like fixed income (doctor, public employee), stocks (technology startup, small business owner), or real assets (real estate broker, mine worker)? Whichever it is, reduce the allocation to that basket. Also, avoid investing in the same industry in which you work.

Match assets to liabilities. Know what you are saving for. It’s easier to finance retirement if you start early, so max out your 401k from an early age. Other shorter term savings goals may be establishing a rainy day fund or saving for a down payment. In this case, the 401k might be in stocks, while the short term savings might be in cash and short term bonds. As you accumulate more assets you can diversify over time. View your mortgage as a loan against all of your assets, not just your house.

Adjust for life stage. Early in your life, it’s probably unrealistic to assume that you can keep the value of your house down to only a third of your assets. (I recommend using the whole value of the house, not just the home equity, in asset allocation.) Also, fixed income investments may increase as you near retirement. Adjust target allocations for your life stage.

Rebalance. Rebalance your investments every six to twelve months. By selling investments that have gone up and buying assets that have gone down, you help yourself “buy low and sell high," which will both improve returns and reduce risk over time.