Wednesday, December 14, 2011

Asset Location is As Important as Asset Allocation


After a year in which the Euro vacillated between survival & collapse, democracy reached the shores of North Africa, and Wall Street got “occupied”, one thing remained sure & true: VOLATILITY.  As I meet with people every day, it is the ubiquitous item that is keeping people up at night as they prepare to transition to & through retirement.  

A 1991 study conducted by Brinson, Singer & Beebower showed that 91% of an investment portfolio's performance is determined by the allocation of its assets—meaning diversifying (& re-diversifying) your investments between different types of companies is the best way to assure long term performance gains & reduce risk.  More recently though, the increasing complexity of economic forces and the interdependence of global markets have contributed to significantly alter the investment landscape. The current market environment poses new hurdles: unprecedented volatility, economic forces putting pressure on equity markets, the prospect of a resurgence in inflation, & rising interest rates, all compounded by unfavorable demographic trends for most of the developed world. In short, to paraphrase an old saying, in today’s investment landscape, the only certainty is that nothing is certain.

Investors can no longer necessarily rely on traditional strategies to reach their financial goals. As a result, traditional diversification (or Asset Allocation, as it is called) may not be as effective as it once was in serving investors’ needs.  However, the concept of choosing investments based on how they correlate with one another—how their prices change in relation to each other—is still an integral part of investment planning. But asset class diversification alone may not get the job done.

What I call “Asset Location” has become just as (if not more) important as asset allocation.  Asset location is about diversifying across different investment vehicles to take advantage of possible tax advantages, income focus, or non-traditional investment classes.  While traditional asset allocation remains important for a significant portion of your portfolio, asset location can help you to build an infrastructure around your investment plan to help weather times of protracted volatility.

This is how financial planning benefits the investor—more specifically, it structures portfolios by combining different asset classes and investment vehicles in an attempt to provide more effective diversification in order to combat volatility, mitigate risk, overcome inflation and provide income in your retirement years.

Please remember that diversification, asset location and asset allocation do not guarantee profit nor protect against loss in a declining market.  They are methods used to help manage risk.