Thursday, April 17, 2008

Asset Allocation - to optimize returns, use the right combination of vehicles

Asset allocation - another funky sounding thinggy. No worries - it's just another term for "investing in different TYPES of stuff" heheh.

Simple example of 2 types or asset classes - equities and bonds / fixed income.
-Equities: You own a part of the item (company, property, etc.) and profit from it's business growth, dividends or bonus pay-out, etc., with no guarantees of any. Aggressive approach
-Bonds / Fixed Income: You lend your $ (investment) to someone (company, government, municipal, etc.) getting a fixed % of returns. Conservative approach

Why would I bother with these two examples instead of plonking all my investment $ in one of them? Simple! I want the best of both worlds

- Equities' average returns (long term) usually beats inflation
BUT there can be years of losses (negative returns) due to economic downturns
- Fixed Income's average returns (long term) usually follows or barely follows inflation (ie. I actually lose purchasing power, not gain)
BUT there can be years where bond returns are higher than Equities' returns.

Take a look at the "Worse Case Scenerio" where if I bought and held Equities on a high of 1997, then the Asian Currency Crisis came and whacked KLCI down to 200+ points, until 10th Mar 2008 post election political sell-off. Who says bonds' returns are ALWAYS lower than equities' returns? ;P

By allocation a % to each of these asset types which are NOT highly positively correlated (ie. if one falls, the other doesn't fall as much or may even be going up), I get an optimized return of minimums with no limits of maximums.

Anyone here heard of "diversification"? What's the difference between "asset allocation" vs. "diversification"?
- Asset allocation: to optimize returns
- Diversification: to reduce risk by spreading your investments within each asset type and subclasses
eg. Equities - spread between Stocks & Properties. In addition, in Stocks, I spread into Financial, Plantation, Manufacturing & Consumer Goods sectors.

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