Wednesday, July 8, 2009

Goals-based asset allocation: Part B

Using the right tool for the job is fundamental in many disciplines. To drive a nail one needs a hammer, to insert a screw, a screwdriver, to screw unsuspecting investors , Goldman Sachs ( But I digress! Actually, from the viewpoint of many investors, all advisors, not just the ones at GS were guilty last year.

"If your only tool is a hammer, every problem looks like a nail." I love that phrase and it applies well to the investment business. Investment advisors too often believe that making as much money as possible is everyone's goal all of the time. Is that equally the case for a 26 year old investment banker and a 68 year old retired school teacher? Maybe, but not likely. So why do advisors push similar solutions for each client?

Whoa! You may argue that giving the retiree a conservative balanced or all fixed income portfolio and the banker an all equities or emerging markets portfolio is providing different solutions. But neither solution was likely constructed based upon that investor's needs only their perceived risk tolerance. What's the difference? Sometimes not much, but usually quite a bit!

If you ask a prospective investor to mentally divide their pool of investment capital into three buckets:
1. Basic needs: food clothing and shelter
2. Enhanced lifestyle: cottage, vacations, French rather than Chilean wine
3. Legacy: grandchildren's education, philanthropy.
a typical split may be 1.(60%) 2.(25%) 3.(15%).

Now assign risks to each bucket.
Bucket 1 is pretty important so you can't take much risk with that one. Perhaps you buy all bonds with this portion.
Bucket 2 gives you more flexibility. Perhaps a 60% equity 40% bond portfolio will address this need.
Bucket three is a long time horizon goal so perhaps 80% equities and 20% bonds works for this piece.

Now you have addressed client goals but investing time horizon needs to be accommodated. More on this in the next installment.

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