Investors are getting nervous as markets are taking a volatile turn. Investors are conducting position audit of their asset allocation portfolio to hedge against wealth destruction. In the next 6-months, investors might confront downside risk of the market. US economy is struggling to cope with low consumer confidence and de-leveraging by the corporate ahead of Christmas. The United States has ignored a “ticking debt bomb” in admitting defeat in reining in the country’s ballooning debt standing at $15 trillion. The US debt “miscarriage” on political wrangling ahead of a US election season would overshadow flimsy market confidence around the world. America’s nonsensical “domestic political wrestling” has proved its inability to “step up and shoulder its responsibility” to help spur sustainable and balanced growth in a bearish world economy. Europe is taking care of the sick children (PIIGS and Hungry now) whose temperatures are not cooling down. Investors are shorting euro currency as markets are slapping from all sides to the unpredictable behavior policies of the European leaders. Global economy will slow down and grow by merely 3.3 per cent in 2012.
Asset mix strategy
Asset allocation is how you balance your wealth among stocks, bonds, cash, real estate, commodities, and precious metals in your portfolio. This mix is the most important factor in your investment making strategy as a success story. It’s 100 times more important than any stock pick. It’s 100 times more important than knowing the next hot country to invest in or what option to buy or knowing what the housing market is doing or whether the economy is booming or busting. I’ve seen ignorance of this topic ruin more investment portfolio value more than any other financial factor. Many investors have no idea what sensible asset allocation is. So they end up taking huge risks by sticking big chunks of their portfolios into just one or two investments. For example, I have a friend who had most of her wealth in real estate investments in Dubai in 2006. When the market busted, she lost a huge portion of investment funds. While in New York in August-2011, I got an important insight from a major player in the global financial market. Robert Kapito, the president of Black Rock asset was advising his clients: 60 per cent in stocks, 20 per cent in short term corporate bonds and 20 per cent in commodities.
Fatal mistake
Consider employees of big companies that put a huge portion of their retirement money into company stocks. Employees of big companies that went bankrupt, like Enron, WorldCom, Bear Stearns, and Lehman Brothers were totally wiped out. They believed in the companies they worked for, so they kept more than half of their retirement portfolios into company stock. It’s all because they didn’t know about proper asset allocation. Because of this ignorance, they lost their wealth. I’m sure savvy investors can see from these examples that asset allocation is so important because keeping your wealth stored in a good, diversified mix of assets is the key to avoiding catastrophic losses and wealth destruction.
Spread the risk – diversify
If investors keep too much wealth – like 80 per cent of it – in a handful of stocks and the stock market goes south, investors will suffer badly. The same goes for any asset gold, oil, bonds, real estate, or blue-chip stocks. Concentrating on your funds nest egg in just a few different asset classes is way too risky for you. Betting on just one horse is a fool’s game and a risky strategy. Spreading of risk is very important and can protect wealth.
ASSET CLASSES FOR INVESTORS PORTFOLIO
Let me walk you through what asset classes are out there and what a sensible mix looks like?
I. Cash is king in turbulent times
First off, you have one of my favorite assets in the world, which is cash.
“Cash” simply means all the money you have in savings, checking accounts, certificates of deposit (CDs) and Treasury bills. Anything with less than one year to maturity should be considered cash. I recommend my investors and clients to keep plenty of cash on hand so that they can be ready to buy bargains in case of a market collapse. Investors flush with cash are often able to get assets cheap after a collapse – they can swoop in and pick things up with cash quickly, and often at great prices. Warren Buffet is a good example and he has shown his worth in these risky times. $10 billion cash investment that he is making in under-valued stocks with high potential. I generally recommend my clients of holding between 10 per cent and 45 per cent of their assets in cash, depending on their risk-reward strategy. In fact, one of the major tenets of good financial planning is to always have at least 12 months of living expenses in cash in case of disaster. If investors haven’t started saving yet, this is the No 1 thing to start today.
II. Stocks are riskier than bonds in the long run: Investors should have conventional stocks. These are investments in individual businesses, or investments in broad baskets of stocks, like mutual funds and exchange-traded funds (ETFs). Stocks are a proven long-term builder of wealth, so I think almost everyone should own some. But keep in mind; stocks are typically more volatile than most other assets like bonds. Investors should stay diversified overall with their asset class with dividend paying stocks. I think investors should stay diversified in their stock portfolio. I once heard a well-known TV money show host ask callers: “Are you diversified?” According to him, owning five stocks in different sectors makes you diversified. This is simply not true. It is a dangerous notion. Famous economist Harry Markowitz modeled math, physics, and stock-picking to win a Nobel Prize for the work on diversification. The science showed you need around 12-18 stocks to be fully diversified.
Holding and following that many stocks might seem daunting – it’s really not. Holding stocks in dividend paying companies is a wealth builder of your portfolio. Keep your portfolio valued and safe against economic turbulence. The problem is easily solved with a mutual fund that holds dozens of stocks, which of course makes you officially diversified.
III. Fixed income securities: Next for investors is fixed income securities, which are generally called “notes” or “bonds.” These are basically any instrument that pays out a regular stream of income over a fixed period of time. At the end, investors also get their initial investment – which is called their “principal” – back. Depending on the investors age, liquid position, exit strategy and tolerance for risk, bonds sit somewhere between boring and a godsend. The promise of interest payments and an almost certain return of capital at a certain fixed rate for a long period of time always lets investors sleep well at night. Adding safe fixed-income bonds to the investor’s portfolio is a simple way to stabilise their investment returns over time. For investors/ clients with enough capital, locking up extra money [more than 12 months of their expenses] in bonds is a simple way to generate more income than a savings account.
IV. Real estate: Another asset class is real estate. Every investor knows what this is, so I don’t need to spend much time covering this. If investors can keep a portion of wealth in a paid-for home, and possibly some income-producing real estate like a rental property or a farm, it’s a great diversifier. Investing in farm land/agriculture in the next 5-years is a wealth protection strategy for the global investors.
V. Insurance of wealth: gold and silver: This is the best asset class in the current scenario. Do I consider precious metals, like gold and silver, an important piece of a sensible asset allocation? I do. Gold and silver are like insurance of wealth. Precious metals like gold and silver typically soar during times of economic turmoil, so I want my clients to own some “just in case.” But I’m different than the standard owner of gold and silver, who almost always believes the world, is headed for hell in a hand basket. I’m a major optimist, but I’m also a realist. I believe in owning insurance. I believe in staying “hedged” and ahead of the game. For many years, my job at a British bank was to develop and implement advanced hedging strategies for wealthy clients and corporations. The goal with these strategies was to protect jobs, wealth, and profits from unforeseen events. During those years, I learned a big difference between wealthy people and poor people. Wealthy people almost always own plenty of hedges and insurance. They consider what could happen in worst-case scenarios and take steps to protect themselves. Poor people tend to live with “blinders” on in difficult times. So just like I wear my seat belt while driving, my clients own silver and gold – just in case. For most people, most of the time, keeping around 15-25 per cent of their wealth in gold and silver provides that insurance. Chinese government has already advocated her people to place 25 per cent of their portfolio in Gold and Silver. Queues outside banks are huge in Shanghai/Beijing for clients who want to own physical Gold and Silver.
Strategic final thoughts
That’s a great view of gold and silver in asset allocation. So, I have covered five broad categories… cash, stocks, bonds, real estate, and precious metals. Do I have any guidelines on how much of each asset folks should own? There’s no way anyone can provide a “one size fits all” allocation. Everyone’s financial situation is different. Asset allocation advice that will work for one investor can be worthless for another investor. But most of us have the same strategic goal: wealth preservation, picking up safe income and safely growing our nest egg. We can all use some guidelines to help make the right individual choices. Keep in mind, what I’m about to share are just important guidelines for the investors
Investors guidelines
If you’re having a hard time finding great bargains in stocks and bonds, I think an allocation of 25%… even 50% in cash is a good idea. This sounds crazy to some people, but if you can’t find great investment bargains, there’s nothing wrong with sitting in cash, earning a little interest, and being patient. If great bargains present themselves, like they did in early 2009, you can lower your cash balance and plow it into stocks and bonds. As for stocks, if you’re younger and more comfortable with the volatility involved in stocks, you can keep a stock exposure to somewhere around 33 per cent – 50 per cent of your portfolio. A young person who can place a sizable chunk of money into a group of high-quality, dividend-paying stocks and hold them for decades, will grow very wealthy.
If you’re older and can’t stand risk or volatility, consider keeping a huge chunk of your wealth in cash and bonds like a 75 per cent – 80 per cent weighting. Near the end of your career as an investor, you’re more concerned with preserving wealth than growing it, so you want to be very conservative. As you can analyse from the above guidelines, the big thing to keep in mind with asset allocation is that you’ve got to find a mix that is right for you that suits your risk tolerance and your station in life. Whatever mix you choose, just make sure you’re not overexposed to an unforeseen crash in one particular asset. This will ensure a long and profitable investment portfolio. Happy investing in volatile times with diversified portfolio.
Shan Saeed is a financial market economist and commodity expert with 12 years of financial market experience. He graduated from University of Chicago, Booth School of Business, USA & IBA Karachi. He can be reached at. Blogs at
www.economistshan.blogspot.com