Making money on Wall Street is usually associated with two major activities: security selection (knowing which stocks to buy) and market timing (knowing when to buy 'em). Toward that end, most investors spend hours culling through research and watching the ticker. This may be fun, but it's futile. Fact is, more than any other factor, it's asset allocation-the practice of choosing the right mix of securities to meet your investment goals-that has the greatest impact on portfolio performance. Shocking as it may seem, more than 91 percent of a portfolio's performance can be traced to this technique.
The secret to a healthy portfolio isn't so much in picking the right stocks as in merely having diversified exposure to the stock market in general. In fact, most experts say the costs associated with active stock-picking-namely research, turnover and taxes-all hamper performance over time.
So what's the bottom line with asset allocation? It comes down to dividing your stash between the three main types of financial investments: stocks, bonds and cash. Your allocation, therefore, is usually expressed numerically in percentage terms. For example, a moderately aggressive investor might have 70 percent in stocks, 20 percent in bonds and 10 percent in cash.
"Asset allocation is a very important tool," remarks Rick Furmanski, president of Concord Investment Company LLC, a private money management firm in Chicago with more than $800 million-worth of assets under management. "In addition to promoting diversification, asset allocation also provides an effective discipline which takes the emotion out of investing."
The process couldn't be more simple. Say Aunt Tilly croaks, leaving you with a $10,000 windfall to invest. Knowing that you've got a five-to-10-year time horizon before you'll need the money, you might put 80 percent in a diversified index fund, 15 percent in a bond fund and the remaining 5 percent in a cash equivalent, like a money market fund. That's all, folks. While everyone else is mulling over Motorola or Microsoft, you're playing ultimate frisbee and letting asset allocation do the work for you.
There are other benefits as well. "Good asset allocation not only helps reduce a portfolio's risk, but is also highly opportunistic," says Jim Henderson of investment firm Vestor Capital Corp. in Chicago. "Having some of your assets in cash, for example, is a proactive way to have some firepower available when good stocks get cheap."
So do you know how many "eggs" to allocate in a particular investment basket? An old-school rule used to be to subtract your age from 100 to determine what percentage of your assets should be in the stock market. More appropriately, however, you should focus on your individual investment goals.
According to research firm Ibbotson Associates 1999 report titled "Investing In Global Assets: A Diversificiation Tool For Portfolios," there has never been a 20-year period of time in which stocks have lost money, which should lead most of us looking toward the far-off future to stuff the bulk of our money in stocks. Generally speaking, as your time horizon or the amount of time before you actually will need the cash increases, so should your exposure to the stock market.
So even as brokers fall over themselves to offer their clients top-notch advice and more services like research, charts and e-mail alerts to induce customers to open accounts, remember that the name of the game is making money, not making trades. And while asset allocation won't inspire the thousands of chat board messages that have become synonymous with today's investment landscape, in the final analysis, perhaps it should.
Jonathan Hoenig is portfolio manager of the Capitalistpig Hedge Fund and author of Greed is Good: The Capitalistpig Guide to Investing (HarperBusiness, $15, www.capitalistpig.com).
Concord Investment Company LLC, (312) 236-1166, www.concordinvestment.com
Vestor Capital Corp. 10 S. Riverside Plaza #1434, Chicago, IL 60606, (312) 641-2400