Know Your Finances: Thoughts on asset allocation

Investing is a tricky business. At any given time there are
just as many compelling reasons to invest as not to invest in an asset. When an
investor’s stocks are sailing with the wind and share prices are rising, they
may have reason to fear that stocks are getting too expensive and wonder how
long until the wind dissipates. When bonds seem like a relatively safe place to
hide, they may fear interest rate hikes could soon sink their bond prices.

All types of assets get caught in the cycle. Small cap
stocks, emerging market stocks, commodities, junk bonds, and treasury-inflation
protected bonds, to name a few, all ride the frothy wave at times. After a time on the wave people start
to figure out that the crest is pretty high and can’t last. But the ride is so
exhilarating and so liberating that it is easy to lose a sense of caution.

Quantitative models that forecast when and for how long a
particular asset will hold its momentum rarely succeed. Human behavior becomes
predictable en masse but unpredictable at the turn, that is, at the point of
change.

So, what in heaven’s name is an investor to do? A
disciplined and experienced investor may manage to mitigate losses by abiding
by two golden rules:
1. Keep it simple. Stocks and bonds generally are usually not positively
correlated to each other, which means that when one of them gets highly
inflated, the other settles down. Money flows back and forth between stocks and
bonds so it is wise to not try to market time the asset groups and best to
maintain a long-term allocation between the two groups in proportions that will
provide a maximum return for that blended risk. One should also diversify in
sub-sectors within the general category of stocks and bonds, such as
international and small cap stocks, and corporate and treasury bonds.

To determine what the blended risk may be, you need to have
an understanding of what the historical volatility of return is for each asset
class. For example, over the last 80 years the average annual return of large
capitalization stocks has been +10%. But most of the actual returns varied
around the average return by plus or minus 20%; that is, most of the actual
returns ranged from +30% to -10%. That’s a lot of volatility. Everything is
relative and though large cap stock returns have higher volatility than bond
returns, they happen to have lower volatility than other groups of stocks such
as small cap or international stocks. Your investment professional can help
educate you about historical returns and the volatility of these returns for
many asset classes.

2. Shut out the masses. There is a constant mass hysteria
that vacillates between exhilaration and fear for various assets and asset
groups in short-term time frames.
Ignore it. Be skeptical. Be more rational and be a contrarian. That
means when the crests get too high you should be selling when others are
buying, and when the troughs get too low you should be buying when others are
selling.

Investing is never easy. But you can manage your risk if you
maintain a disciplined approach and stay on top of the fundamentals and invest
for the long term.

Currently, the stock market has a lot of positive momentum.
In fact, the first quarter earnings reports have been quite strong. Companies
are increasing guidance and analysts are raising earnings estimates. Stock
prices are not yet in bubble territory but they aren’t cheap either. Now may be
the time to be on alert for trimming stock positions that are reaching
unsustainable price to earnings levels. Yet human behavior does just the
opposite, it wants to chase the heck out of this rise while assuming that the
wave will only get higher.

Of course, I can’t say for sure when the wave will peak out.
We haven’t even reached the October 2007 market heights yet. But I can tell you
that every single market time period is unique and unpredictable. Save yourself
some heartache and stay diversified and balanced in your asset risk!

About Ellen Le

Ellen is the Founder and President of Ascend Investment Management. She was born in Philadelphia and has lived in the Delaware Valley for most of her life. When she is not researching investments and managing portfolios, she pursues her interests in tennis, bridge, hiking and art. Beginning her investment career in 1981 as a stockbroker at E.F. Hutton and Co., Ellen now has over 20 years of investment management experience. Prior to founding Ascend in 2006, she managed high net worth assets for many years at Bank of America, Mellon Bank, and most recently at Davidson Capital Management. At Davidson Capital Management, Ellen served as a Senior Vice President and Senior Portfolio Manager of the firm. She managed assets for more than 50 family relationships and was a core member of the firm’s Investment Committee.Ellen earned a BA in History from Brown University and a MBA in Finance & Investments from The George Washington University. She is a member in good standing of the Chartered Financial Analyst (CFA) Institute, which is a global organization dedicated to setting a high ethical standard for the investment profession. Her professional memberships include the Delaware County Estate Planning Council, Women Enhancing Business (WEB), and the Chadds Ford Business Association. She is a docent with the Delaware Art Museum and an active volunteer with the Brown University Alumni Association.