Recently I found an important article online about how much of a portfolio's performance is attributable to asset allocation. I have seen it referenced several times in the past, and would like to share it with you, as the point is crucial. According to the study done by Roger G. Ibbotson and Paul D. Kaplan, more than 90% of the variability of performance over time is due to asset allocation. What does this mean? This means that the way you allocate your assets accounts for 90% of the way your investments perform.
What is asset allocation? Very simply put, it means putting a set percentage of your assets into different types of investments. Let's look at an example of asset allocation. A typical asset allocation could be 50% stocks, 30% bonds, and 20% cash. The actual amounts allocated in this example for a $ 600,000 portfolio would be $300,000 in stocks, $180,000 in bonds, and $120,000 in cash or cash equivalents.
A decision is made based upon risk level and expected performance as to what percent should be allocated into various asset classes. An asset class is simply a type of investment, such as stocks or bonds. If the current price of the asset class is considered with regard to how an asset has performed in the past, it is likely that the portfolio will perform better.
Follow the link below to read this interesting article.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=279096
Various types of investments perform differently simply because of what is happening in the economy and other reasons. One may go up while another goes down or stays even. This study found that the way you have divided your assets into the different categories accounts for 90% of your portfolio’s performance. Understanding asset allocation, then, is paramount to wise investing.
Safe Investing,
Camille
