VISTA, Calif. – While investment policy establishes the value and purpose of maintaining wealth, asset allocation is the road map to building wealth.
Asset allocation takes into account the nature of various investment vehicles, including return expectation and volatility in up-and-down markets, investment style, diversification among industries and domestic versus global opportunities.
Sometimes, tribes specify an allocation into programs that provides social, rather than monetary, return. Examples include matching funds into individual development accounts and grants to charitable entitles (such as First Nations Development Institute) that provide basic financial management education.
Return encompasses interest or dividend income and increases or decreases in the original capital.
Volatility refers to the market value of the investment. The value of stocks and bonds, even real estate, fluctuates up or down. Some investments fluctuate more than average, while others fluctuate less. Those that fluctuate more are generally regarded as being more risky.
Investment style refers to the temperament of the portfolio. A conservative portfolio is one that tends to have more certainties in return, such as interest from bonds, dividends from high-yield stocks, or other income from investment properties. An aggressive portfolio is one that tends to focus on appreciation of the original capital, and its market value is generally more volatile than the more conservative portfolios. A moderate portfolio is a blend.
Diversification refers to the mix of investments in the portfolio. It is the concept of not putting all eggs in one basket. Investment returns fluctuate with market cycle. Even economies in the world do not perform in sync. It is necessary in order to even out the overall performance.
In general, bonds provide a predictable series of interest payments over time. At a finite maturity date, the principal is returned. However, not all bonds are the same. Like individuals, some bond issuers have better credit rating scores than others. Bond issuers with poorer credit usually have to pay higher interest to compensate for the risk.
Usually, stocks are regarded to carry higher risk than bonds. It is because there is no finite date of maturity and principal is not guaranteed. While past performance is no guarantee of future return, some common traits can be noted within the stock market. Certain companies seem to be able to weather economic cycles better than others. They are called blue chip stocks because they can consistently increase their earnings.
Some companies may be new but offer cutting edge products and services. With brands such as Google and eBay, their stocks may have done well because of their dominance in the marketplace. Three decades ago, a whiz kid by the name of Bill Gates foresaw the growth potential in personal computers and built a software empire based on this vision.
Companies may not do well all the time. In such cases, investors may sell off the shares to a price level at or below asset value. Legendary investors such as Warren Buffet use this value-based technique to amass the second largest fortune in the United States today.
In the past three years, real estate prices sky rocketed across the country. Prior to this phase, there was a period of 12 years when prices did not rise. Professional investors managed their portfolios accordingly: they took advantage of cash flow rather than quick appreciation. Now those times have changed, there is more focus on capital appreciation that can be realized by selling.
Many foreign economies are growing. China and India are rapidly expanding their infrastructure. As high oil and gas prices brought greater prosperity to Canada, Russia and Central American countries, they also have more to spend. An investor can capture these opportunities by investing in companies that provide goods and services to these emerging markets.
There should be different allocations for different portfolios. For example, funds set aside for a brand new tribal hall should have the most conservative allocation. Principal cannot be put at risk. However, funds for the purpose of maximum return can be allocated beyond fixed income, into equity positions of domestic and global companies.
Asset allocation is about making a pie with slices of these components and a range of how much these slices can shrink or expand. For example, if a portfolio were to have 17 percent slices in bonds, blue chip stocks, growth stocks, value stocks, real estate and international investments, the range for each may be 12 percent to 22 percent. Rebalancing would take place at set times of one to four times a year, when positions would be trimmed back and others added.