Saturday, July 02, 2005

Asset allocation

Maximizing returns and minimizing your risks is the magic to achieving your investment goals and getting a good night's sleep. You can achieve these seemingly opposed aims by distributing you investments in different assets this is asset allocation.

According to studies by Nobel laureate William Sharpe and researchers like Brinson, Hood and Beebower (1986), asset allocation accounts for more than 95% of all variance in quarterly returns. (for purposes of this discussion I will restrict myself to non real estate assets). Using Ibbotson's data from the past 70 years on expected returns and standard deviations (geek speak for reward and risk), I ran some excel magic and came up with what I think is an ideal asset allocation for your non real estate investments.

If you are a US resident below 35 years of age

US bonds 15%
US Large caps 25%
US Mid Cap 15%
US Small cap 10%
International 25%
Commodities 5%
REIT’s 5%

Of course do not forget to keep 4-6 months of expenses in liquid cash for emergencies. As you age you want to reduce your exposure to stocks and increase exposure to bonds.