The Importance of Asset Allocation: A Strategic Guide

The Importance of Asset Allocation: A Strategic Guide

An asset allocation is the distribution of investments across categories like stocks, bonds, cash and real estate. It will evolve and change based on your personal financial situation. Our goal in setting an asset allocation is to configure your entire wealth to help you achieve your financial goals. The overarching idea is that one can look beyond diversification (spreading investments within a category), and holistically balance risks and rewards based on your own goals, risk tolerance and timeline.

Asset Allocation Key #1: Risk Management

Diversification, reducing risk to a specific asset or factor, is the only “free lunch” in the investment world, meaning that there is not a large cost involved in spreading out your investments. As such, we have extolled the virtues of broad diversification within our portfolios (in which we usually own 70 to 90 stocks) since the first edition of The Prudent Speculator went to press in March 1977. While we would certainly argue that the selection of stocks in a given portfolio is important, so too is the amount of wealth dedicated to a certain area of the investable universe. In our wealth management experience, a person’s asset allocation is often the most important determinant of long-term performance.

Asset Allocation Key #2: A Wide Set of Investment Choices

We build allocation portfolios on an investment foundation which we think is improved by a broad slate of investment choices available to our clients. While an investor’s individual considerations and circumstances ultimately drive what goes into the final asset mix, we have broken the investment universe into several main categories.

Asset Allocation Key #3: Equities are Usually the Base

A diversified core stock portfolio with a Value tilt serves as the main growth engine for most investor allocations. Our approach is focused on total returns (capital appreciation + dividends), while keeping risk-related characteristics top of mind. We seek to bolster returns by opportunistically buying undervalued companies in any market environment and selling them when they’ve reached their full appreciation potential.

Factor-oriented strategies (such as Dividend Income, Small-Mid Dividend Income and International Value) function as complementary allocations to core stock holdings. Investments in certain historically rewarded factors seek to enhance the risk-reward calculation, add income via dividends and diversify an allocation without watering down the return.

Asset Allocation Key #4: Consider the Role of Fixed Income

A portfolio of laddered fixed income securities is constructed with the primary goal of preserving principal, acting as a store of savings. Secondarily, it should produce a meaningful after-tax income yield. From an allocation perspective, the capital preservation goal seeks to provide a source of liquidity that supports active rebalancing in the event of market downturn. In many situations, Fixed Income serves as the largest allocation (as a percentage of overall wealth) to meet spending needs in retirement, preserve capital for a near-term cash need or serve as a ballast for clients that do not (or cannot) weather an equity downturn.

Asset Allocation Key #5: Widen the Opportunity Set

Direct ownership of real assets, including real estate, offers the potential to compound at a rate similar to publicly traded equities (REITs, mostly), but without direct correlation to day-to-day stock market movements and in a tax-efficient manner.

Private equity investments are frequently appropriate for investors with long investment time horizons and an appetite for growth. In exchange for longer lock-up periods, private equity placements (often in attractively priced, privately held companies) can offer returns well in excess of comparable stock market index returns, albeit with higher risk.

Your Financial Foundation

Our broad suite of investment opportunities come together as a foundation for wealth building through our comprehensive financial planning capabilities, which are extensive and touch on a wide range of areas, dependent on client-specific needs. We provide an objective and long-term approach to constructing your customized financial plan. We work as a team and function as the “quarterback” between you and your existing attorneys, tax advisors and insurance agents. And, in cases where you aren’t currently engaged with these professionals, we have a network to which we can connect you.

Our wealth advisors and financial planners are seasoned professionals who have spent much of their careers performing objective planning. Our process addresses investment management, estate planning and tax-related issues. Our process typically includes:

• A cash flow plan that serves as a roadmap to ensure you are optimally allocated and that you are setup to achieve your goals – including spending before and during retirement, as well as incorporating philanthropic and legacy goals.
• A comprehensive review – and recommendations on all other aspects of your financial life, including compensation & employee benefits, risk management (personal insurance) and tax planning.
• A review of your existing estate plans and a “coaching” call to prepare you for meeting with an estate planning attorney, once you are at that stage in your financial life.

We Want to Hear from You

For more than 47 years, we have collaborated with our clients in their investment decision making process as they pursue their long-term financial goals. We are committed to keeping your goals, concerns and attitude about investing at the heart of your plan. If you’re ready to experience our personalized investment approach and exceptional client service, contact Jason R. Clark, CFA at 949.424.1013 or jclark@kovitz.com.