So what is the proper allocation for you to achieve the risk adjusted return that you desire? Well, the first that you should probably determine is how much risk are you willing to take? Shaping an asset allocation is going to be largely impacted by your personality — will you be able to sleep at night knowing that your money is being subject to significant market fluctuations? Do you need immediate liquidity? These are important questions to ask yourself before you begin designing your own allocation (or buying pre-packaged products [to be discussed in the next segment]).
For those individuals who aim to preserve their capital (and this is their #1 priority) I would generally recommend that a portfolio be be structured to maintain in excess of 80% of their value in cash and cash equivalents (money markets, treasuries and commercial paper). High liquidity is a major benefit of this portfolio allocation — many individuals favoring this portfolio style have a need for capital within the next 12 months. Please note, while this structure may have less market risk, it does open you up to the risk of losing money over time because the appreciation of assets may not keep pace with inflation.
For individuals desiring current income, we can expect a similar (majority) component of the portfolio to be composed investment-grade, fixed income obligations of large, profitable corporations, real estate (usually REITs), treasury notes, and, to a lesser extent, shares of blue chip companies with long histories of continuous dividend payments. Usually, the investor who prefers this type of allocation is one who is income-oriented — usually nearing retirement or structuring some way to preserving the principle (with some upside potential) of a significant cash inflow (inheritance, etc.).
For most of us, we can find a certain level of comfort in a “Balanced Portfolio.” Most people find a sense of emotional comfort in knowing that this portfolio is structured as to balance long-term growth and appreciation of assets and current income. An ideal mix of assets would include those that generate cash as well as those that appreciate over time. Well balanced portfolios mitigate the risk of medium-term investment-grade fixed income obligations, shares of common stocks in leading corporations (some but not all that pay dividends), and real estate holdings via REITs. Generally, a balanced portfolio is always vested (meaning very little is held in cash or cash equivalents unless the investor (either you or a portfolio manager) has determined that there are no compelling opportunities.
Jason Gilbert is Managing Director of RGA Investment Advisors LLC. He has over 10 years of experience in investment advisory, including portfolio construction, financial strategy, and advanced planning for high-net worth and institutional clients. He maintains an extensive background in both forensic accounting and personal finance, and serves as a fiduciary and trusted partner to his long-standing clients.