…Asset allocation…explains 100% of investment performance – yes, all of it. Accordingly, most of your time, energy and money should be spent on asset allocation…and a plan for asset allocation is called an investment policy.
…Asset allocation are risk decisions designed to achieve objectives with an acceptable likelihood…This risk decision is called “risk willingness” or “risk necessity” and needs to be conditioned on three more decisions:
- Do you have the risk capacity for this level of risk?
- There’s a time in everyone’s life when risk capacity is very low because the stakes are as high as they will ever be. You cannot afford to lose money at this critical juncture in your life
- What is the smartest way to take this risk?
- Be as diversified as possible: global stocks and bonds, real estate, commodities, etc. Diversification provides the best returns for the risk over time.
- How can you take this risk at the lowest cost?
- Costs reduce returns and the desire to diversify and to keep costs low has recently driven investors to passive index investing, especially in Exchange-Traded Funds (ETFs).
In summary, smart asset allocation integrates risk willingness with risk capacity, is broadly diversified, and low cost. The good news is that there are tools to be smart.
…In a nutshell, it’s a “Keep your eyes on the prize” process focused on establishing and achieving goals through the combination of intention and attention. Importantly, the process shuns costly distractions like stock picking and market timing.