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Editor's Note

by Charles Rotblut, CFA

Editor's Note Splash image

Asset allocation is a focus in this month’s issue, with three articles devoted to the subject.

Why the emphasis? Because how you allocate assets in your portfolio directly determines both the likelihood of achieving your financial goals and the financial risk you take. Follow too conservative an allocation and you may run out of money in retirement. Take on too much risk and you may find your portfolio severely damaged during periods of market turbulence.

Most often, investment success is not determined by whether you picked the best stock or fund, but by how you managed your portfolio’s allocation. If this sounds counter-intuitive, consider that when the markets turn turbulent, many investors tend to fret and then sell. When the markets rebound, the same investors tend to keep their money in cash or bonds, waiting for a clear signal that it’s safe to get back into stocks again. This behavior locks in losses and causes them to miss out on gains.

It’s not just conjuncture, either. Research firm Dalbar calculates that the average equity mutual fund investor lost 5.73% last year, even though the S&P 500 index had a total return gain of 2.12%. You can’t blame the fund managers for this discrepancy—the average large-cap fund listed in our mutual fund guide lost just 0.9% in 2011. Rather, the discrepancy was due to investors making poor asset allocation decisions.

This month’s issue provides guidance on how to better manage your portfolio.

The first article was written in response to member requests for a portfolio with reduced or low correlations to large-cap domestic stocks and long-term government bonds. Creating the portfolio was akin to being a mad scientist walking into a laboratory. I wasn’t completely sure what would happen once I started mixing non-traditional asset classes into a portfolio beaker. What came out was an interesting blend that worked well over the past 10 years and may have a role as a supplement to a traditional allocation strategy. Click here to see my alternative blend.

The second article comes from Sheldon Jacobs, the founding editor and publisher of The No-Load Fund Investor newsletter. Sheldon walks you through the basics of portfolio allocation, giving you a road map of how to build a diversified portfolio. He then goes a step further and gives you a list of factors that can help you tailor an allocation strategy to your personal needs. Sheldon’s article begins here.

The third article is an interview with David Darst, the chief investment strategist at Morgan Stanley. David explains how asset allocation can both protect your wealth and preserve your purchasing power. You can read the transcript and get his personal insights here.

Part of allocation involves investing in bonds, and I know many of you are worried about the impact that potentially higher future interest rates will have on bond prices. This is why when fixed-income experts Hildy and Stan Richelson proposed writing an article about how to deal with inflation, I gladly accepted. The Richelsons explain how bond ladders can turn rising rates into an advantage here.

Bond ladders are also the subject of Robert Muksian’s article. Robert, a professor of mathematics at Bryant University, shows how you can use a bond ladder to create a guaranteed stream of income throughout retirement. The details of his model for a pseudo–life annuity are here.

Though the cost of low bond yields is very apparent, the cost of dishonesty is often opaque. Duke professor Dan Ariely believes investors incur higher costs because of the financial industry’s bad incentive structure. A transcript of our conversation about dishonesty and behavioral economics appears here.

Finally, we discuss two new features on AAII.com: the AAII Blog and the Model Portfolio Update email. You can learn about both in our annual Member News here.

Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal
twitter.com/charlesrotblut

Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


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