Asset Allocation: Investing by the Numbers

1. Asset allocation is an investment planning tool, not an investment strategy --- few investors make the distinction. Investment strategies are used to implement the asset allocation formula that investment planning produces. Investment Planning is an integral part of financial planning.

Financial planning is the broader concept, involving such considerations as: wills and estates, insurances, and  trusts. Investment planning takes place within trusts, IRAs, etc. It cannot be done properly in most 401ks.

2. Asset allocation allows investors to structure investment portfolios by "purpose", and in a manner most likely to accomplish goals established for each portfolio within the investment program.

It balances each portfolio between Growth Purpose and Income Purpose securities, and needs to go no further. Security sub-classes have little relevance, and should be avoided in accordance with the KISS principle.

3. Equities expose investors to more "financial" risk than income securities, but not because of market price fluctuations that get so much media attention. They are riskier because they represent ownership in a business enterprise that could fail. The risk of loss can be minimized within the security selection process first and with proper diversification,second.

The primary purpose for buying equities is to sell them for capital gains, not to save them as trophies to brag about in chat rooms. They can be screened and selected in a manner that makes them less risky than other, non-income purose securities.

4. Income securities are inherently less risky than equity securities because they represent debt of the issuing entity, and owners of debt securities have a stronger claim on the assets of the issuer. Stockholders have to rely on drooling class-action attorneys to mitigate losses if the company fails.

With proper selection criteria and diversification, the risk of capital loss is negligible and price fluctuations can be mostly ignored except for the trading opportunities that they provide. The primary purpose of these securities is income generation, either for current consumption or for use later in life. Capital gains should be taken at the "one-year's-interest-in-advance-level" --- and bragged about in those chat rooms.

5. The asset allocation plan is a long-range, semi-permanent, decision that has nothing to do with market timing or hedging. It is designed to produce a combination of capital growth and income that will achieve the long-range goals of the investor. 

It must not be tinkered with because of expectations about anything, or rebalanced arbitrarily because of natural changes in the market value of one asset class vs. the other. An asset allocation mutual fund is an oxymoron.

6. Asset allocation is the only proven cure for inflation. If properly managed using The Working Capital Model, it will increase the level of portfolio income by more than the rate of inflation, which measures the purchasing power of your dollars, not the dollar value of your purchases.

100% equity portfolios are less inflation proof than any same-size, balanced, portfolio. A secure "base income" is needed to take advantage of market price fluctuations in both Asset Allocation "buckets'".

7. An equity-only asset allocation requires professional greed management in strong markets where there are more profit taking opportunities than lower priced bargains, investors tend to force the issue with lower quality stocks, story stocks, new issues, etc --- ignoring the inevitability of the next correction.

A 30% or more income allocation (as required when using the Market Cycle Investment Management methodology) can be a major focus factor, and it will keep the "base income" production line moving upward during any market environment.

8. Income Securities (notably income Closed End Funds) need not have price stability in addition to their role in providing income. Their prices may fluctuate in either direction in anticipation of changes in expectations about the direction of interest rates... this is a good thing, and it provides periodic profit taking, income compounding, opportunities.

9. If you focus exclusively on market value, dwell upon comparisons of your unique portfolio with the market averages, expect performance of some kind during specific time intervals, and listen intently when someone speaks about the future, any asset allocation work you do will be ineffective.

10. Cash is not an investment and not an asset class within the asset allocation model. Entities that include cash in their portfolio mix are using it as a hedge against market movements that they want investors to think they can predict..

Market-timing efforts have no place in asset allocation planning or thinking. Asset allocation transcends both short-term market trends and long-term market cycles.