Asset Allocation is an Investment Planning Tool, not an Investment Strategy --- few investment professionals understand the distinction. Fewer still have discovered the power of: "The Working Capital Model"!
The problem that most investors have is that they use the wrong number to determine their Asset Allocation in the first place. Neither market value nor the Calendar Year should be relevant issues!
NOTE: The Working Capital Model is the copyrighted intellectual property of Steven R Selengut, Author of "The Brainwashing of the American Investor: The Book that Wall Street Does not Want YOU to Read".
The only reason for a person to assume the risks associated with investing is the possibility of achieving a higher rate of return than is attainable in (the very few) risk free depositories for their capital (money). Investing is a get rich slowly process, conducted in an uncertain environment --- one that must be understood and managed in a way that minimizes the risks involved.
The "Working Capital Model" accomplishes this by eliminating the need for impersonal comparisons with arbitrary and unrelated numbers and time periods. It works best with portfolios that are diversified among individual securities that are at the same time of high quality and income producing. The key to successful Investment Management is Asset Allocation, the process of dividing the available investment dollars into two, and only two, buckets: Equity Investments and Income Producing Investments.
All investment grade securities fit within one of these two classifications, based solely upon the primary purpose for their ownership. There are several key issues involved in successful Asset Allocation:
* Understanding the Purpose of each Security owned,
* Being true to the Asset Allocation Formula,
* Knowing the Cost Basis of the securities in the portfolio,
* Worshiping Cash Flow, and accepting the "Smart Cash" concept. Smart Cash is that which arises from earned income of any kind, including Capital Gains.
Most humans enter the investment process greed first, thus transforming a relatively simple wealth enhancing exercise into a mass of confusing products and philosophies, destined to expand the pocket books only of the the creative souls that produce them.
* Very simply, the purpose of any Equity Investment is the eventual production of a "realized capital gain", a profit. This profit need not be huge, but it should be "targeted" in advance as a guideline and it certainly should be above the guaranteed return in a bank account. The profit must be realized as soon as it is available, so it is helpful if Equity Investments are housed in Tax Deferred quarters.
The "Working Capital Model" works best with Equity Investments that pay dividends, but this is more of a "quality assurance" element than it is a cash flow consideration. The primary purpose of Equities is profit production, quickly. (Thou shalt not fall in love with any Equity holding... ever!)
Fixed Income Securities should be the easiest to understand and to deal with... they aren't! Fixed Income securities are primarily income producers, and they can be held for extensive periods of time doing absolutely nothing but producing cash flow. That is job one.
Most Fixed Income Securities represent a contractual obligation between a corporation and investors: interest, dividends on a preferred stock, returns of principal, royalties, rent, etc, will be paid at periodic intervals. Investors become creditors of the issuing entity. Obviously it pays to lend money only to corporations, municipalities, and others that have solid finances themselves.
Typically, longer loan commitments produce higher rates of return than shorter ones and AAA Insured obligations produce lower yields than those of a lesser quality. "Investment Grade" falls somewhere in between, and this is where The "Working Capital Model" keeps investors focused. All Fixed Income Securities are "Interest Rate Sensitive" and will rise or fall in price depending on day to day perceptions about the direction of interest rates.
This is expected and totally irrelevant. In fact, if an investor purchases the securities in the Fixed Income portion of the portfolio properly, he or she will be able to add to holdings when they move higher in yield, AND to sell the securities profitably when they move higher in price. Wall Street Financial Institutions and Financial Professionals are constantly informing and instructing investors, in the fixed income area, to ignore the Market Value Gyrations of Income Securities, for example:
- The Primary purpose of these securities is income generation and investors should never accept or consider a lower rate of return in an effort to reduce volatility.
- Investors should never avoid adding to the Fixed Income Asset Allocation "bucket" for fear (or in anticipation of) higher interest rates.
- The "Working Capital Model" recognizes this, and works well with sound financial advice as it deflects the temptation either to transact or to sit back for the wrong reasons.
(For a tutorial on Fixed Income Investing, click here.)
The Asset Allocation Formula is the mission statement that defines the long term structure and nature of the Investment Portfolio. By simply stating, for example, that the portfolio is to be 60% invested in equities and 40% in fixed income, an investor has proven that: he has analyzed his personal situation carefully and determined that this structure is most likely to achieve his long term goals.
The Asset Allocation Formula is often misused and abused in an effort to superimpose a valid investment planning tool on speculation strategies that have no real merits of their own. For example, "annual portfolio repositioning", "market timing adjustments", and shifting between Mutual Funds.
To be effective, Asset Allocation must be implemented as an on-going process that is to be tended to with every investment decision. The Asset Allocation formula itself is sacred, and if constructed properly, should never be altered in any respect due to conditions in either the Equity or Fixed Income markets.
Changes in the personal situation, goals, and objectives of the investor are the only issues that can be allowed into the Asset Allocation decision making process. It operates above the whims and cycles of the markets... Income and Equity.
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WCM - Part 2 <--
