Asset Allocation 101

By Julie Neitzel

Financial markets have experienced considerable volatility over the last few years. Given these challenging times, it’s easy to forget the rationale for your current investment portfolio holdings and how they fit within a comprehensive, long-term investment plan. Since asset allocation is a key determinant of investment returns, this month’s column will explore key considerations in the asset allocation process.

As Ralph Seger said, “An investor without investment objectives is like a traveler without a destination.” It’s important to ask yourself if the goals have been explicitly stated for your investment portfolio. This is a critical determinant in the asset allocation process that requires soul searching and understanding possible outcomes.

At times, financial institutions use jargon that may not be fully understood by a client with regard to risk and investment goals. If an investor’s goal is to have the highest probability that his capital will be preserved and his income needs will be met, then the allocation of more defensive strategies should be incorporated into his investment plan. While shorter duration investment grade bonds may be unexciting and provide low yields in the current market, they may be the critical defensive portion of the investor’s portfolio.

When building a client’s strategic asset allocation, private banks and asset management firms typically use capital market expectations that have been developed based on 20-year forward return/risk expectations. Many times, investors do not understand that there could be periods of negative returns for a given asset class during the initial investment period, but that the investment returns are expected to average out near their long-term capital market assumption return.

Risk tolerance also can be difficult to define for many investors and is not always well-communicated by the investor or his advisor. For example, during the global financial market freefall of fall 2008, the S&P 500 equity index lost nearly 40 percent in value, which surprised many investors. Although it was a “black swan” event, meaning there’s a low statistical probability of this circumstance happening, it did, and some investors became uncomfortable with this level of risk. Fearing that they would lose their entire investment, many sold their investments, only to miss the future recovery and appreciation in the years following the crisis.

In 2013, the investment grade municipal bond asset class lost 3 percent, primarily due to concerns that interest rates would rise and that the credit quality of the bonds was being questioned. Few thought that this defensive asset pool would ever generate a negative annual return, and certain investors sold based on the fear that these assets would further depreciate, only to miss the strong returns delivered in the following year.

The dot-com boom lulled investors into speculative investments. Many unrealistically believed that large returns could be generated on money-losing businesses.

To fully understand risk, it is important to comprehend key variables, including the possible range of return scenarios (positive and negative), the worst value drawdown experienced in history, the risk of total loss and the risk level an investor can comfortably accept.

The investment time horizon is also very important. The longer the investment time period, the more likely an investor will achieve his goals. As Benjamin Franklin said, “Money makes money. And the money that money makes, makes money.” Further, Albert Einstein is purported to have remarked that the most powerful force in the universe is compound interest. The key to compounding is the snowball effect that happens when earnings or appreciation generate even more earnings and/or appreciation over time. This is particularly powerful in retirement accounts where investments can grow tax-deferred or even tax-free. Time in the market is often more important than timing the market.

Finally, it is generally understood that holding one’s investments in cash is not a good long-term strategy (although cash is a good hedge to buffer market volatility), since 1) current low rates provide little or no yield on cash; 2) as things cost more over time, it’s important to preserve one’s purchasing power; and 3) making one’s assets productive, particularly with current expected longer life spans, is critical to have assets for the future.

Given these factors, strategies that offset low cash returns and provide income and principal appreciation over time are important to include in one’s investment mix. The key is to get the proper mix of investment assets, to review one’s asset allocation regularly and adjust accordingly. Remember, a slight tweak in one’s asset allocation could make a meaningful difference in the future, given the power of compounding. ¿

Julie Neitzel is a partner and advisor with WE Family Offices in Miami and a board member of the Miami Finance Forum. Contact her at or 305.825.2225.

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