Sunday, October 18, 2009

Coming Soon....

Inquiry Posting : An introduction to Real Estate Investment 2
Return compounding frequency
Inquiry posting : An introduction to REIT
Risk tolerance vs timing of investment
Inquiry posting : Effect of floating rate versus fixed rate in real estate investment with leverage
Investment style - Market timing, averaging and rebalancing.
Demonstration - Market timing, averaging and rebalancing
Inquiry Posting : Real estate investment – factor to consider
Marking to market vs none marking to market

The important of asset allocation decision

A major reason why investors develop investment plan is to determine an overall investment strategy.

Though an investment plan does not indicate which specific stocks to purchase and when they should be sold, it should provide guidelines as to the asset classes to include and the relative proportions of the investor’s funds to invest in each classes. How the investor divides funds into different asset classes is the process of asset allocation.

Rather than present strict percentages, asset allocation is usually expressed in ranges. This allows the investor with some freedom, based on his or her reading of capital market trends, to invest towards the upper and lower end of ranges.

For example, suppose an asset allocation strategy requires that common stock be 60 to 80 percent of the value of the portfolio and that bond should be 20 to 40 percent of the portfolio’s value.

If an investor is particular bullish about stocks , she will increase the allocation of stock towards the 80 percent upper end of the equity range and decrease bond toward the 20 percent lower of the bond range. Should she be more optimistic about bonds, the investor may shift the allocation closer to 40 percent of the funds invested in bonds with the remainder in equities.

Asset allocation focus on asset classes to be considered for investment and weight assigned to each eligible asset class.

Strategic asset allocation decision assists investor on having a disciplined approach to investing.

At different time horizon, different classes of asset perform differently.

For example, safe Certificate of Deposit or high quality bond investment will sometimes outperform equities, and, because of their higher risk, common stocks sometimes lose significant value. These are time when undisciplined and uneducated investors become frustrated, sell their stocks at a loss, and vow never to invest in equities again. But once market back in bull run situation, this undisciplined investor due to emotional influence , will jump in again and buying at high price.

In contrast, there are times where disciplined investors stick to their investment plan and position their portfolio for the next bull run. By holding on to their stocks and perhaps purchasing more at depressed prices, the equity portion of the portfolio will experience a substantial increase in the future.

Asset allocation decision determines most of the portfolio’s return over time. Although seemingly risky, investors seeking capital preservation, income, or even capital appreciation over long time periods will do well to include a sizeable allocation to the equity portion in their portfolio. This is to factor in the risk of not meeting long-term investment return goals after considering inflation and taxes.

Investor make asset allocation decision in much the same manner but factor such as different social , economic , political and tax environment will cause minor different on strategy across countries.

National differences can explain much of the divergent portfolio strategy. Country with population at lower average age will tend to have greater use of equities.

Inflation rate in a country is another factor affecting asset allocation strategy. Country with relatively higher inflation rate will tend to have greater use of equities to generate higher return to compensate for losing in purchasing power due to inflation.

Investor from country with better pension plan and social benefits such as medical will tend to invest less in equities as capital appreciation is not as important to generate future income when entering spending phase as most funding requirement will able to support by pension plan and social benefits.

Country with risk averse investor and believe that equities is a form of gambling rather than investing will tend to invest less in equities market.

Country with relative liquid stock market will increase the use of equities in asset allocation decision.

In summary, Investors need to develop an asset allocation strategy which matching their risk return profile.

For an investor who is risk averse with expected lower return, higher proportion of investment fund will be allocated to lower risk investment such as Bond and Certificate of Deposit ( Certificate of Deposit is considered no risk if the amount is protected by Central Bank ) and lower proportion into risky stock investment.

In contrast, for an investor with high risk tolerance and looking for high return, higher proportion of investment fund will be allocated to stocks and lower proportion into Bond or Certificate of Deposit.