Asset Allocation

“The reason that most individuals tend to underperform over the long-term boils down to a failure to understand risks, which include the need to diversify their resources. Or a process known as asset allocation…”

Most individuals often make the mistake of not assessing downside risks when they make their first investments.

This is especially true when they take the first tentative steps into investing in the stock, currency, commodities markets or even buying into an unit trust.

Many tend to view their investments with a short-term perspective. More often than not, they tend to focus on the upside potential rather the risk of losses.

After all, how often have we heard of friends or office acquaintances making a quick punt on the stock market on a “hot tip”. Even if they do make quick gains, the likelihood is that these DIY or do-it-yourself investors will risk losing more of their money in the long run.

This probably explains why 9 out of 10 Singaporeans who used their CPF funds to invest in the stock market in 1999 came off worse.

That was despite the fact that the Strait Times Index rose more than 158% from a low of 800 to 2,067 between September 1997 and 1998. Most of the investors would have done better if they had kept their money with the Central Provident Fund and earned a modest interest of about 3.5 to 4.4 percent.

In contrast, most unit trust managers were able to chalk up a 20 to 40% gain with a few exceeding 100% over a one-year period.

The reason that most individuals tend to underperform over the long-term boils down to a failure to understand risks, which include the need to diversify their resources. Or a process known as asset allocation.

Smart investors do not try to second-guess all the time where the market or individual sectors or interest rates are heading.

Instead, what they do is to try to diversify or spread their investments in a manner that will help them ride the up trends while minimising losses when market conditions turn sour.

The process which they use to achieve this is known as asset allocation – a well-tested method which research has shown to be more important than which individual stocks, bonds or other investment vehicles to pick.

In fact, it has been proven that 90% of a portfolio’s performance over a long period of time can be attributed to asset allocation rather than stock picking or market timing.

The objective of the asset allocation process is two-fold :

– To reduce your exposure to investment risks while trying to maximising returns.
– To invest in a manner that will meet your future needs.

And total asset allocation goes a step further. Besides equities, bonds and unit trusts, it also takes into consideration investing in less liquid assets such as property as well as intangibles such as meeting your insurance or education needs.

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. A chief measure, Consumer Price Index (CPI).

According to the calculation above, you need to pay $111.36 now to buy the same goods or services, which was worth $100 in 1999.

Real investment return= Nominal return – Inflation rate