Asset allocation is the technical term for how you divide your portfolio between different types of financial asset.
You’ll often hear it said that asset allocation is the most important thing you can do for your portfolio. And of course it’s true. If you could pick out the best class of asset each year, be it bonds, equities, or commodities, then you stand a pretty good chance of amassing fortunes. After all, there’s always a bull market in something.
But then again, none of us has a crystal ball. What are the chances of you picking out the right asset classes?
And even if you thought you could, it’s inadvisable to chop and change your portfolio radically and too often. The costs mount up and you’re bound to get your timings wrong anyway.
The way I see it, what you’ve got to do is say to yourself “where would I like to be a few months from here – where am I going with my portfolio?” – identify a goal and gradually work towards it. Use opportunities as they present themselves and gradually work towards your destination.
Today I’d like to give you an overview of the direction I want to take next year. I’ll take the four main asset classes and give you a brief summary of where I’m going with each.
The last couple of years have been tough. We’ve lived under the constant threat of a market correction – be it trouble in Europe, the emerging markets, or the powder keg that is the Middle East. And, of course Western debt looks increasingly like a time-bomb… it’s just the fuse wire looks a little longer than perhaps it has been in the recent past.
But that doesn’t mean we have to play the ultimate fear card – ie go to cash. I have kept a useful amount of powder dry – specifically 25% over the last couple of years. Some in sterling and some in more worthy foreign currencies.
And overall, this stance has served me well – at least it hasn’t cost me much in terms of opportunity costs. I mean, the FTSE is only modestly higher than a year ago and commodities are down, and bonds have had a pretty good year. Who would have thought that as things stood at the end of last year? It just goes to show the value of diversification – I’m pleased to have maintained my 25% weighting in bonds.
But I’m not happy to sit on this much cash as we head into 2013. I think the risks of a major equity blow-up have receded. Of course, the risks are still very much out there – and therefore a decent slug of cash is advisable. But overall, I’m looking to trim my cash to around 20%.
Of course that cash is going to have to go somewhere…
The CRB Commodities Index comprises 19 commonly traded hard and soft commodities, as well as oil and gold. It covers a wide base, but it’s a useful barometer for this diverse asset class. As you can see from the chart, the year started off well, but suffered as the summer brought with it an emerging markets slowdown. From there things have recovered somewhat, so overall, we’re down only about 3% on the year.
CRB Commodities Index
Not everyone is keen on commodities. But I am. Especially gold. I’m going to use the current soft price in gold to continue adding during 2013.
I’ll be looking at other commodity plays where I think there’s value too. But overall, with the growing allure of gold, I’ll be looking to have 30% in commodities.
Bonds and fixed interest
I’ve already mentioned that bonds had a pretty good innings during 2012. And many of the investments are looking fully valued right now.
As I say, it’s incredibly difficult to get your timing right as you adjust allocations – especially when it comes to picking the top of a market. And seeing as I believe interest rates will stay low for quite a while, I’m happy to keep a healthy amount of my pot in bonds.
But overall, I want to trim bond and fixed interest down from 25% to 20%. I’ll be cutting out some of the bonds that have performed best over the last few years, and anything that matures during the year will be won’t be reinvested.
There’s no doubt that at 25%, my equity exposure has been quite stingy for someone of my age. Maybe that’s because I’m a little bit more sceptical than most of my age…
But a low exposure to equities hasn’t really cost me much. The FTSE 100 yields about 3.5% – and in terms of capital, we end the year up about 5%. No great shakes!
But I should also point out that I’ve traded quite nicely in and out of the FTSE too. I hope you enjoyed learning about Bollinger bands during the year. Basically I used this simple tool to help me make some short term gains trading in and out of the FTSE using a spread bet. It’s important to remember that market volatility can be a useful ally – we certainly shouldn’t react in blind panic to market gyrations.
I expect there’ll be plenty more volatility to come this year. I’ll certainly be using the Bollinger bands to help time my moves.
My asset allocation adjustment for 2013
|2012 allocation||2013 allocation||Change|
These adjustments are relatively small. And they’ll happen as and when the right opportunities arise, be it for liquidations or fresh investment.
Stay with me as we enter boldly into what is very likely to be an eventful 2013.
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