Tuesday, February 3, 2009

Asset Allocation - How to allocate your money in your portfolio

After a person has decided to invest, the most important decision a person has to make is asset allocation. i.e. How much money will be allocated to each asset class.

For recapitulation their are several asset classes that one can invest their money in. I would leave out the most difficult and complex which are not worthy to invest into.

1. Stocks
2. Bonds
3. cash
4. Fixed deposits or certificate of deposit
5. Precious metals

The first decision to take is how much risk you can tolerate. You can learn about risk and risk tolerance here. Because some of those assets can vary widely in value, can crash and be wiped out, then your tolerance such risks and changes in the value of your portfolio will determine how much you allocate in each class.

The following list the asset class from the most risky to the most safe.

stocks, precious metals, bonds, cash, certificate of deposits

However the riskier an asset class the more the return associated with it. So those that want to have high return will have to increase the percentage of risky assets in their portfolio.
Hence there are several ways to allocate assets in a portfolio based on the tolerance of risk and the return required.

High risk, high return
100 % stocks and high yield bonds

medium risk, medium return
50 % stocks, 25 % cds, 25 % bonds

low risk, low return
25 % stocks, 25 % cds, 50 % bonds

Inflation hedge
75 % gold and silver, 25 % bonds indexed with inflation

Hyperinflation portfolio
100 % gold and silver

I choose the medium risk and medium return portfolio. I think that it can cater for all types of catastrophe in the market.

The choice is yours guys.




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2 comments:

  1. This is a nice article. But I would like to point out a missing part. You have not mentioned the 'age' as a criteria to select the right portfolio. for example, a person who is near to the retirement is not recommended invest his major chunk of money to the equity investments.

    Sherin
    The Money maniac blogger

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  2. You are right I forgot the age aspect. The older a person is the more secure and less risky his portfolio must be.

    The rule for someone who has medium risk tolerance is to have bond and Cds have the same percentage as his age.

    Hence approaching retirement the portfolio must have more bonds. Bonds tends to reduce the variation in value of a portfolio.

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