As I’ve mentioned before, asset allocation is essential for both investment returns and your peace of mind and I’ll explain how it relates to your finances. Asset Allocation is the process of dividing an investment portfolio among different asset categories, like stocks, bonds, and cash.
Using different asset categories is important because historically the returns of each category have not moved up and down at the same time. So, by investing in more than one category, you’ll reduce the risk of losing money in any one type of market.
So how do you decide how much money to devote to each asset type?
- Get an idea of your risk tolerance – How much risk can you handle? Do you have time to let your money grow and discipline to leave it alone through market downturns?
- Figure out if you need income from your investments or cash on hand for large expenses – Use this risk tolerance assessment to help you get started.
- Choose an asset allocation – Once you decide how much risk you’re comfortable with, you’re ready to choose an asset allocation. Use this asset allocation key as an example of a portfolio that would be appropriate for your risk tolerance.
If we look at the economic tea leaves for the remainder of 2009, here's what economists are generally predicting:
The worst is over! The economy is transitioning from a steep recession to recovery. Let's hope they are right on this one. Here's a break down of their projections:
- Jobs - Unemployment, currently in the 9% range, will creep up to double digits in the 10+ range. There appeared to be a leveling off of initial claims in May, which suggests that yes, people are still losing jobs, but at a slower rate than earlier this year.
- Interest rates - Possibly bad news for homeowners. Even though the Fed is committed to keeping rates low, it looks like they are going up before year end. It certainly appears that they could be up by 1% or 100 basis points.
- Home sales - the free-fall in home prices has stopped, but sales will remain slow.
- Economic growth - The economy shrunk at an annual rate of 5.7% in the first quarter of 2009. Projections are that this is the worst quarterly drop for the year. We should start to see some growth by the fourth quarter.
- The stock market - No matter how we measure the equity markets, they are all up significantly since their March 9 bottom. This is definitely a leading economic indicator.
Good news? Definitely some. We could use some, especially if you are one of the unemployed.
Let's take a good look at the equity markets. The U.S. equity markets for 2009 have been rallying for the last couple of months:
Since the March 9th low, the DOW has gained 26%. YTD, it is down 5.8%. The S&P 500 has gained 30% since March 9th. It is down just over 1% YTD. The NASDAQ, which consists of approximately 3,800 companies, is up 32% since the low and is up 6.5% YTD.
International markets have fared even better. The EAFE, which is an index of developed markets, is up 2.5% YTD and the emerging markets index is up 26% YTD. If we break the international markets down even further, we see that country specific returns have ranged from -1.5% and -1.9% in Germany and the UK to 30.5% and 45 % in Brazil and China. Clearly there has been a large divergence in both U.S. and international markets.
The big question is: will this last or is this a short-term bear market rally? History tells us that all of the equity markets will eventually return to historic averages. Is this the time to jump back in if you are out, or if you never got out should you stay in? If you stayed in, stay in! If you liquidated a portion of your portfolio you may want to consider the process of reallocating back to equities with some of your dollars.
The economy is rebuilding and, as I've shown you, so is the stock market. This may be the time to remember an old Norwegian proverb: Sell in May and go away.