What Is Asset Allocation?

Asset Allocation, Diversification, and Your Portfolio

First Published: ADawnJournal.com March 3, 2010

Asset allocation is an investment strategy which simply entails allocating your assets (your investment portfolio) among different categories of investments, such as stocks, bonds, money market funds, cash etc. Asset allocation helps to minimize risks and maximize gains because it diversifies your portfolio among various types of investment or investment products instead of keeping them in one place.

What Types of Asset Allocation Will Work Best For Me?

Although there are many rules of thumb regarding asset allocation, no one can tell you exactly which one is right or which one is wrong for you – as this is a very personal matter which largely depends on various factors as described below:

·   Time Horizon: Time horizon is how much time you have ahead of you to invest in reaching your financial goals. An investor with a longer time horizon has time on his side and will be able to choose volatile or riskier products for maximum returns – because if markets go down, this investor can wait to ride out the volatility. On the other hand, an investor with shorter time horizon will not be able to afford risky product, as he will not have the luxury to wait for the market to go up if he falls into financial meltdown.

·   Risk Tolerance: Risk tolerance is your ability to take risks for better returns. In the investment world, risk and reward are inextricably entwined. If you are young (like in your 20s or 30s), you may not care that much about losing 35% of your value, as you know you have a long way to go. But when you are in your 40s or 50s, with kids’ education and retirement in mind, a 20% drop in your portfolio may be enough to lose sleep at night.

·   Investing Is An Ongoing Learning Process: In my book Invest Now, I have mentioned that investment is nothing but a discipline, and it has to be orchestrated with great passion and care. Investment is not like going to the shopping mall and buying a few things impulsively – it is a lifelong learning process. Asset allocation or any other investment ideas are not set in stone and these will change as time changes. Always upgrade yourself with financial changes in the broad global perspective and you will have to change your investment strategies to bridge the gap between the present and the future.

·   Individuality Counts: Although you will find there are many rules of thumb or pre-made portfolios when it comes to asset allocation, there is no single allocation or portfolio available that will be right for everyone. Everyone is different and so should be their asset allocation. The onus is on you to find out the best asset allocation that suits your needs.

What Are Some Major Asset Categories?

These days, a wide array of investment products exist to give you a wide range of asset allocation with a broad diversification. However, there are only three major asset categories I will mention here:

·   Equities or Stocks: The word “stock” is interchangeable with “share,” “equity,” “security” and so on. Stocks represent ownership in a company and historically offer the greatest risk and highest returns among other asset groups mentioned here. Stocks should not be used as a short term investment as it can be very volatile to hold for a short period of time.

·   Fixed Income Investments or Bonds: Some other fixed income investment products are government savings bonds, bond mutual funds, etc. These types of products are less volatile than equities and offer modest returns as well. Fixed income products can offer steady flow of income – depending on its objective.

·   Cash Equivalents or Cash: This can be plain cash or products like savings accounts, money market funds, treasury bills, etc. These are considered the safest investments with minimal returns with almost no risks.

Why Asset Allocation Works?

Due to economic and market conditions, no one can predict the best performing assets and it varies year to year. Time has proved that during bad and good economic times, all asset classes do not move in the same direction. By diversifying your assets among various categories, you are minimizing your risks. If one asset class goes down, the other asset class is there to protect you by averaging out. Also, to reach your financial goals, you need to balance your portfolio by keeping both high-return and low-return investment products. If you keep only one type of product in your portfolio, you may never be able to reach your investment objectives – as it will be either too risky or too safe. Asset allocation helps you to diversify and balance your portfolio.

What Are Some Common Asset Allocation Rules of Thumb?

There are so many rules of thumb on this topic that it can be overwhelming. Many consider a neutral asset allocation should be 60% stocks and 40% bonds. Another rule of thumb goes like: subtract your age from 100 and you will get the percentage to hold in stocks. For example, if you are 40, 100-40 = 60% of your portfolio should be in stocks and 40% should be in bonds.

Is Diversification Same As Asset Allocation?

The old saying “Don’t put all your eggs in one basket” was good advice 100 years ago, and it will be good advice forever. Whether you are a first-time or a veteran investor, you always need to spread out your investments to minimize your risks. Diversification refers to the process of spreading investments among various equities. Asset allocation refers to the process of spreading investments beyond multiple equities and over several asset classes such equities, bonds, cash, etc.

Asset Allocation is a diversification strategy that helps you to offset decline in any particular asset classes by gains in other asset classes – thus reducing the fluctuations of performance of a portfolio. It is unlikely that all asset classes will go downhill at the same time.

Do You Have Your Own Asset Allocation Model Portfolio?

Yes, to make investing simple and worry-free, I have invented a model portfolio called “A Dawn Timeless Portfolio” or simply ADTP. You can read more about ADTP here – (I am still working on this project and will add a link once done)

To find many other online asset allocation calculators, do a search by entering these keyword phrases: “asset allocation calculators,” “portfolio asset allocations tools,” etc.

Last Word

Model portfolios and asset allocation tools are to help you understand asset allocation. Do not blindly follow any model portfolios or tools just because it looks cool. You are different than anyone else – make an educated decision based on your time horizon, risk tolerance, financial goals, and your overall financial situation.

What Is Inflation?

Inflation: Definition and Causes

First Published: ADawnJournal.com March 7, 2010

When there is economic trouble, you often hear about inflation. Inflation is something that many people know about, but few people actually understand. Yet, inflation plays a very important part in our lives. If not for inflation, everything would still cost a few cents, but because of inflation the price of a can of Coca-Cola has gone from five cents to over a dollar.

Essentially, inflation is the rise in the price of goods and services over a period of time. Some define inflation as the loss of purchasing power because when a price level rises, the unit of currency (the dollar for example) buys few goods and services. While in the past one dollar could buy a lot of things, these days it buys barely a can of Pepsi.

Governments around the world, as a result, pay a great amount of attention to the inflation rate, which is the percentage change in the price index over time.

Inflation is not all bad of course. There are both good and bad effects of inflation that should be understood. The good things about inflation include the fact that it prevents recessions and provides debt relief by lowering the real level of the debt. In addition, it helps to eliminate expensive debt since the value of the dollar changes over time. However, there are some bad points and they include lowering the economic productivity rate, cause shortages of goods and services and reduce the investment in capital that helps keep an economy going.

Canada has gone though many different levels of inflation during good and bad times. For example, between 1966 and 2004, the country reached an extreme low of level of inflation in 1994, when it was near zero, while in 1974 the inflation rate went past 14 percent. This just shows how much the inflation rate can shift for a country during good and bad times.

High inflation is caused by huge growth in the supply of money, while low inflation is caused by small fluctuations in the demand for goods and services. The growth of inflation at a steady rate over time is usually attributed to the growth of an economy. For example, the United States had its economy grow slowly between 1900 and 1950, and inflation moved slowly. However, the economy grew greatly from 1950 to 2000, which accounted for the huge increase in the price of items.

Most western countries, including most of Europe, Canada and the United States, have very low levels of inflation. This shows that these economies are relatively healthy and less volatile. The inflation rate of Canada and the United States is usually about 1.5 percent per year.  Many developing countries have a very high rate of inflation, including Afghanistan and Mongolia, which both have inflation rates in excess of 25 percent. This shows that these countries lack stability and have a very volatile economic situation. As well, the worse the inflation, the less likely investors will invest in a currency of a country.

As for what causes inflation, this is much harder to determine. When economies are in trouble, inflation rates can increase, but they also increase when economies are doing well. Most economists have a general idea of how inflation works, but more or less it is seen as a by-product of our modern capitalistic world and something that is not completely understood, least of all by regular people

Globe Investor’s New Terrible Site Redesign and Why Is It Time to Switch to Google Finance Canada

Globe Investor’s Recent Terrible Revamped Website

First Published: ADawnJournal.com March 7, 2010

I know what you will say once see the title of this article: Globe Investor comes nowhere near comparing with Google Finance Canada and they are meant to be used for different purposes. And up to now, I have totally agreed with you. However, I have changed my mind once I actually experienced their new redesigned site last week.

It is hilarious to see these mega sites trying to put on a huge show through online advertisements and campaigns to announce their new revamped site design – and then come up with a site that is much worse and more user unfriendly than previous versions.

What don’t I like about the new Globe Investor? Basically everything. They tried to make it look like a high-tech website by putting too many nice pictures and big stock market chart; however, they forgot one main element – simplicity.

When you open globeinvestor.com, the first thing that you notice is that almost all of your screen is covered with a gigantic market summary chart and a couple of pictures. And then, if you keep scrolling down, you will be bombarded with about 15-20 sections/columns with big pictures representing each one of them. Let’s say, if you want to find your favourite sections, or any specific columns, there is no way you can find it in a snap. The front page takes about 5-6 page down to see the whole thing.

A simple test you can do right now to see how inefficient and cluttered Globe Investor is. How much time you would need to browse all sections and important highlights on mega sites like Google.ca/finance, Economist.com or IHT.com? I can do in about 20-30 seconds. How long it would take to do the same birds-eye-view scan of heavily cluttered Globe Investor home page? Give yourself an A+ if you can do it in 1 minute.

On a regular weekday, I usually browse Globe Investor 10-12 times and Google.ca/finance 2-3 times. However, starting now, I will flip it to Globe Investor 2-3 times and Google.ca/finance 10-12 times. Finding time is complicated enough and there is no point making it more complicated with the new revamped Globe Investor. Google Finance is may be miles away from Globe Investor in terms of offering features and customization, but I know it won’t take long for Google Finance Canada to catch up. After all, Google always seems to redesign and add features keeping simplicity and what readers want in mind – not the other way around.

How to Build an Investment Portfolio

How to Create an Investment Portfolio

First Published: ADawnJournal.com March 14, 2010

What Is An Investment Portfolio?

An investment portfolio is nothing but your collection of investments. You can hold a wide range of investments such as stocks, bonds, money market instruments, and so on in your portfolio. The objective of building a portfolio is to minimize risks and maximize return by diversify it among variety of investments. Diversification can be made within same asset class or across different asset classes. Research has shown that a diversified portfolio spreading across different classes always is the key to build a successful portfolio.

What I Need To Consider Before Building A Portfolio?

There are various factors you should consider before start building a portfolio. These factors are:

– Your time horizon
– Your risk Tolerance
– Your investment objects etc
I discussed about these in another article. Please follow this link to read it – What Is Asset Allocation?

Are There Any General Rules of Thumb Building An Investment Portfolio?

There are too many, actually. I would have to say, the most common rule is the 100 – age rule. This is simply getting the percentage of stocks and bonds you should hold by subtracting your age from 100. For example, if you are 30, you should hold (100 – 30) 70 per cent stocks and 30 per cent bonds. As you grow older, you should be reducing your stock portion according to this rule. When you are 60, you should be holding 40 per cent stocks and 60 per cent bonds.

Another simple portfolio building approach is the Neutral Allocation – which is holding 60 per cent stocks and 40 per cent bonds. Two other portfolios worth mentioning are Lazy man or couch potato portfolios by Scott Burns and The Permanent Portfolio by Harry Browne.

To find many other portfolio ideas, do a search by entering these keyword phrases: “investment portfolio mix,” “portfolio asset allocations tools,” “model investment portfolio,”etc.

Do You Have Your Own Investment Model Portfolio?

Yes, to make investing simple and worry-free, I have been invented a model portfolio called “A Dawn Portfolio” or simply ADP. You can read more about ADP here – (I am still working on this project and will add a link once done)

To find many other online asset allocation calculators, do a search by entering these keyword phrases: “asset allocation calculators,” “portfolio asset allocations tools,” etc

Last Word

Of course, you need to decide if the recommended allocations match with your personal risk tolerance and market views. Investments must be considered in context

If you are at all interested in asset allocation strategies, I strongly recommend that you read about the science. Don’t just follow conventional thinking and rules of thumb.

Ten Timeless Personal Finance Tips By Financial Author Ahmed Dawn

Ten Timeless Tips For Financial Success

First Published: ADawnJournal.com December 1, 2009

The financial crisis is making a lot of people realize that they don’t know how to manage money.  Unfortunately, this is not taught in our schools, but Canada’s Personal Finance Blog – A Dawn Journal is here to help you. This article will teach you all the basics you need to become financially successful. Visit A Dawn Journal regularly for more articles like this.

1. Spend less than you earn. If this is something you can’t do, make arrangements to bump up your income by taking a part-time or an additional job. This number one tip is the most important, timeless financial tip ever. If you can’t do it, all or any other financial tips will be meaningless.

2. Track your spending. I don’t believe that a dollar-for-dollar budget works. However, you should have a rough idea of how much you spend on certain categories. Keep track all of your expenses and adjust necessarily among various categories, i.e., if you see you are spending too much on entertainment, take steps to reduce your expenses. At the end of the day, your expenditures have to be lower than (as mentioned in point 1) your earnings. Use free personal finance software to keep track of your expenses.

3. Pay yourself first. Set aside at least 5-15% (do 5% if you have loans, do more than 5% if you don’t have loans, credit card balances etc) of your gross income into your investment account, savings account, RRSP, TFSA or so on every month. Set up an automatic plan to do it regularly.

4. Have an emergency fund. Have six months’ worth of living expenses in a high interest savings account for emergencies.

5. Set goals. Know exactly when you want to pay off your loan, buy a car, buy a house, and when you want to retire.

6. Pay your credit card balances in full every month. If you already have credit card debt, pay it off first. Credit cards charge the most interest. It is a good idea to pay off credit card balances with a line of credit account, which charges half the interest.

7. Try to avoid buying a car. If you still need to buy, buy a used car. A new car depreciates about 35% the moment you drive it off the lot.

8. Pack your lunch. If you eat out every day, your approximate cost would be as below:

Weekly Cost = $10 * 5 = $50

Monthly Cost = $50 * 4 = $200

Yearly Cost = $200 * 12 = $2,400

$2,400 annually is a lot of money. If you are in a 42 % tax bracket, for example, you keep 58% of each additional dollar you earn. When you consider all the taxes and costs associated with earning that after-tax $2,400, saving $2,400 annually means actually saving $4,000 in pre-tax savings (all figures are approximate). Let’s put it another way – if you can brown bag your lunch, think of it as you are giving yourself a $4,000 raise annually.

If you can’t pack every day, pack at least two to three times a week.

9. Start investing. Investment is nothing but a discipline; it has to be orchestrated with great passion and care. Investment is not like going to the shopping mall and buying a few things impulsively. Start investing for the long run, and keep adding money every month or every week. Stay invested for the long run-through good times and bad, through market ups and downs. If you don’t know how to start investing, I recommend reading Invest Now. Anyone can become a successful investor by following three simple and practical steps mentioned in this book. If you are not comfortable investing on your own, seek professional help. I recommend fee-only financial advisors.

10. Review your progress at least once a year. If you are not satisfied with achieving your financial goal, change or modify your financial roadmap. If you are not sure what actions to take, consult a fee-only financial planner.