Can You Invest Successfully through asset allocation?
by Weldon J. Reeves, CPA

Bob Jones and Cynthia James, two hypothetical investors, are both 40 years old. Both want to retire at age 65 and both have $100,000 to invest.

Twenty-five years later, Bob retires with $230,682. Cynthia, however, has amassed a whopping $1.1 million-plus, endowing the phrase "golden years" with an entirely new meaning.

How can this happen? It seems that Bob put his money in a bank certificate of deposit with an average annual yield of 3.4 percent. Every year he paid taxes on the interest earned, and many years the interest he earned did not even recoup the rate of inflation.

Cynthia, on the other hand, placed her cash into a portfolio that was balanced among various types of investments, or assets. This is a process known as asset allocation. Studies show that asset allocation is the single most critical step investors can take to build wealth over the long run.

Too many investors focus on choosing different bonds, different stocks or different mutual funds. But the real issue for those who want to accumulate wealth should be how to divide their money among various investments to maximize returns and minimize risk.

Here's a simple overview of how asset allocation works. To achieve the performance that built up Cynthia's hypothetical nest egg, 25 percent of her $100,000 was put into municipal bond mutual funds. Another 20 percent was invested in equity mutual funds, while 20 percent went to international equity and bond funds. Real estate investments received 20 percent of the money, 10 was allocated to precious metals and 5 percent went into energy funds. Please keep in mind that this example of asset allocation strategy is for illustrative purposes only and may not be appropriate for every investor.

In allocating her dollars this way, Cynthia took advantage of the tendency of these assets to perform well at different times. Real estate and precious metals values, for example, tend to peak during periods of high inflation, while fixed income investments, such as bonds, tend to decline. Equities tend to do well when interest rates decline.

Over time, the strong performances among various asset classes reduce the impact of weaker returns. Cynthia used an asset allocation strategy to reduce her risk by not putting all of her eggs or dollars into any one investment basket.

Another advantage of the allocation process is that the mix of asset classes can be tailored to each investor's goals and temperament. Those who are aggressive can skew their portfolio toward stocks, while conservative investors' portfolios will favor fixed-income assets and cash.

In this example, Bob and Cynthia will experience a very different standard of living. Bob may face financial hardship. Cynthia, however, shows that those who make wise use of asset allocation, as well as patience and discipline, could look forward to an affluent retirement.

Note: CDs are federally insured and offer a fixed rate of return, whereas both the principle and yield of investment securities fluctuate with market changes.

Studies conducted by Gary P. Brinson, L. Randolph Hood & Gilbert L. Beebower. "Determinants of Portfolio Performance," Financial Analysts Journal, May/June 1991, Brinson, Singer, Beebower.

The author is a CPA and a registered representative of Signal Securities, Inc. Securities placed through Signal Securities, Inc., 700 Throckmorton, Ft. Worth, TX 76102, (817) 877-4256. Member SIPC.

Weldon Reeves is a CPA specializing in tax and personal finances. He consults with major corporations on employee benefits issues. For more information on the services Weldon offers, check out his web site at www.reevescpa.com or email him at weldon@reevescpa.com.

The author is a CPA and a registered representative of Signal Securities, Inc. Securities placed through Signal Securities, Inc., 700 Throckmorton, Ft. Worth, TX 76102, (817) 877-4256. Member SIPC.

View Weldon's Bio