book

Asset Allocation For Dummies®

Name: Asset Allocation For Dummies®
ISBN: 9780470409633

by Dorianne Perrucci, Jerry A. Miccolis

May 2009

Beginner

360 pages

8h 26m

English

For Dummies

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Copyright
About the Authors
Acknowledgments
Publisher's Acknowledgments
Introduction
About This BookConventions Used in This BookWhat You're Not to ReadFoolish AssumptionsHow This Book Is OrganizedPart I: Discovering the Not-So-Secret Recipe for Asset AllocationPart II: Getting StartedPart III: Building and Maintaining Your PortfolioPart IV: Going beyond the BasicsPart V: The Part of TensIcons Used in This BookWhere to Go from Here
I. Discovering the Not-So-Secret Recipe for Asset Allocation
1. Understanding Asset Allocation
1.1. Figuring Out Why Asset Allocation Is So Important1.1.1. Encapsulating the Enron story1.1.2. Exploiting the 90 percent solution1.2. Uncovering the Basics of Asset Allocation1.2.1. Balancing risk and return1.2.2. Selecting your asset classes1.2.3. Determining your asset mix1.2.4. Rebalancing your asset mix1.3. Getting Started with Your Investment Strategy1.4. Building Your Portfolio and Keeping It True to Your Long-Term Goal1.4.1. Selecting securities1.4.2. Mastering asset location1.4.3. Monitoring your portfolio to stay on target1.4.4. Measuring your results1.5. Reaching Past the Asset Allocation Basics1.5.1. Adding alternatives1.5.2. Tackling taxes1.5.3. Altering your allocation1.5.4. Embracing expert help
2. Weighing Risk and Return
2.1. Measuring Return2.1.1. Total return and its components2.1.2. Nominal return versus real return2.1.3. Understanding time-weighted return versus dollar-weighted return2.1.4. Annualizing multiyear returns2.1.5. Accounting for taxes, fees, and expenses2.1.5.1. Considering the taxes that affect your investment returns2.1.5.2. Understanding fees and expenses2.2. Measuring Risk2.2.1. Differentiating between volatility and risk2.2.2. Understanding how volatility erodes return: Risk drag2.2.3. Using statistical measures for risk2.2.3.1. Range2.2.3.2. Standard deviation2.2.4. Factoring in your time horizon2.3. Evaluating the Trade-Off between Risk and Return2.3.1. Recognizing that there's (usually) no such thing as a free lunch2.3.2. Heading for the efficient frontier
3. Making Sense of Asset Classes
3.1. Identifying the Traditional Classes3.1.1. Embracing equities: Stocks and stock funds3.1.1.1. Size3.1.1.2. Sector3.1.1.3. Style3.1.2. Getting a handle on fixed-income investments: Bonds, bond funds, and more3.1.2.1. Understanding how bonds work3.1.2.2. Exploring the three major types of bonds3.1.2.2.1. U.S. government bonds3.1.2.2.2. Municipal bonds3.1.2.2.3. Corporate bonds3.1.2.3. Getting familiar with bond mutual funds3.1.2.4. Considering other types of fixed-income investments3.1.2.4.1. Mortgage-backed securities3.1.2.4.2. Collateralized debt obligations3.1.2.4.3. Preferred stocks3.1.2.4.4. Convertible bonds3.1.2.5. Checking up on a bond issuer's credit3.1.2.6. Laddering by maturity3.1.3. Capitalizing on cash and cash equivalents3.1.3.1. Certificates of deposit3.1.3.2. Money-market deposit accounts3.1.3.3. Money-market mutual funds3.2. Understanding Alternative Investments3.2.1. Looking at your options for alternative investments3.2.1.1. Investment real estate3.2.1.2. Hard assets (commodities)3.2.1.3. Hedge funds3.2.2. Knowing when to add alternative investments to your portfolio3.3. Going Global with International Investments
4. Determining the Right Proportions: Your Asset Mix
4.1. Putting the 90 Percent Solution to Work for You4.1.1. Keeping your eye on the important 90 percent: Allocating your assets4.1.2. Avoiding focusing on the other 10 percent4.1.3. Embracing asset allocation's guiding principle4.2. Laying the Foundation for Successful Asset Allocation4.2.1. Understanding correlation4.2.2. Discovering the appeal of non-correlated assets4.2.2.1. Understanding non-correlated assets4.2.2.2. Finding non-correlated assets4.2.2.3. Realizing how 2 + 2 can equal 5 in your portfolio4.2.2.4. Making Rudolph the Red-Nosed Reindeer work for your portfolio4.2.3. Finding the holy grail of asset allocation: Perfect negative correlation4.2.4. Seeking stability and vanquishing volatility4.2.4.1. Appreciating the virtue of stability4.2.4.2. Avoiding the cost of volatility4.3. Recognizing the Most Important Features of an Asset

5. Stirring the Mix: Portfolio Rebalancing
5.1. Getting Your Free Lunch with Rebalancing5.2. Understanding the Power of Rebalancing5.2.1. How rebalancing works: Unlocking the energy of the periodic table5.2.2. Making volatility work for you: Volatility pumping5.2.3. Memorizing the mantra: How rebalancing forces you to buy low and sell high5.2.4. Being a contrarian: Making sure you have the right mindset for rebalancing5.3. Following the Right Rebalancing Schedule5.3.1. Rebalancing on fixed calendar dates5.3.2. Planning your rebalancing for the greatest opportunity
II. Getting Started
6. Laying the Foundation for Your Plan
6.1. Seeing Your Investment Horizon Clearly6.2. Setting Your Return Objectives6.3. Making Decisions about Your Risk Tolerance6.3.1. Evaluating your experience6.3.2. Considering risk questionnaires and other tools6.4. Setting Your Portfolio Constraints6.4.1. Recognizing positions you won't get out of6.4.2. Identifying investments you won't consider6.4.3. Limiting your exposure to certain asset classes6.5. Reviewing Your Tax Situation6.5.1. Being mindful of your current and future tax brackets6.5.2. Looking for opportunities in prior tax returns6.5.3. Considering which of your assets are in tax-deferred accounts6.6. Taking Account of Special Circumstances6.6.1. Protecting your assets from lawsuits6.6.2. Protecting your estate from taxes6.6.3. Simplifying your holdings
7. Developing Your Investment Strategy
7.1. Understanding the Lifetime Cash-Flow Projection7.1.1. Getting a feel for the basics7.1.2. Recognizing the link between your asset allocation and your Lifetime Cash-flow Projection7.2. Coming Up with an Outline for Your Long-Term Financial Plan7.2.1. Assets7.2.2. Liabilities7.2.3. Income7.2.3.1. Compensation: Wages, salaries, and bonuses7.2.3.2. Pensions and retirement account distributions7.2.3.3. Stock options7.2.3.4. Annuities7.2.3.5. Social Security7.2.3.6. Withdrawals7.2.4. Expenses7.2.4.1. Annual living expenses7.2.4.2. Loan payments7.2.4.3. Medical care7.2.4.4. Education costs7.2.4.5. Weddings, vacations, and other special events7.2.4.6. Taxes7.2.4.7. Savings7.3. Putting It All Together: Making Lifetime Cash-Flow Projections7.3.1. Salary and other income7.3.2. Expenses7.3.3. Investment returns7.3.4. Taxes7.3.5. Savings or withdrawals7.3.6. Assets7.3.7. Liabilities7.4. Testing "What If" Scenarios7.4.1. What if you retire early?7.4.2. What if you start a family or have more children?7.4.3. What if you want to change your career?7.5. Determining How Your Asset Allocation May Affect Your Lifetime Cash-Flow Projection7.5.1. Estimating returns7.5.2. Reckoning risk7.5.3. Working risk and return into your Lifetime Cash-flow Projection7.6. Documenting Your Strategy: Drafting Your Investment Policy Statement
8. Creating Your Allocation Plan
8.1. Selecting Your Asset Classes8.2. Establishing Your Asset Class Mix8.2.1. Go long! Finding percentages for the long haul8.2.2. Picking the right percentages8.2.2.1. How the pros do it8.2.2.2. How you can do it8.3. Looking at Some Sample Allocation Percentages8.3.1. Aggressive: Higher equity percentage8.3.2. Conservative: Higher fixed-income percentage8.3.3. Moderate: Right in the middle8.4. What about Subclasses?8.4.1. Figuring out your fixed-income subclass allocation8.4.2. Establishing your equity subclass allocation8.4.3. Arming your portfolio with the appropriate alternative subclasses8.5. An Asset Allocation Case Study8.6. Setting Up a Schedule to Revisit Your Plan
III. Building and Maintaining Your Portfolio
9. Buying Securities
9.1. Deciding What to Buy9.1.1. Individual securities9.1.1.1. Stocks9.1.1.2. Bonds9.1.1.3. Real estate investment trusts9.1.2. Funds9.1.2.1. Mutual funds versus exchange-traded funds9.1.2.1.1. Mutual funds9.1.2.1.2. Exchange-traded funds9.1.2.2. Index funds versus actively managed funds9.1.2.2.1. Index funds9.1.2.3. Target and life-cycle funds9.1.3. Other investments9.1.3.1. Annuities9.1.3.2. Options9.1.3.3. Structured notes9.1.3.4. Exchange-traded notes9.2. Figuring Out How to Buy Securities9.2.1. Buying through a broker9.2.2. Buying on your own9.3. Understanding Fees and Expenses9.3.1. Mutual-fund fees9.3.1.1. Shareholder fees9.3.1.2. Annual operating expenses9.3.2. Brokerage fees
10. Knowing Where to Put Your Assets: Asset Location
10.1. Viewing Your Accounts Holistically10.1.1. Considering taxable accounts10.1.2. Understanding tax-deferred and tax-free accounts10.2. Understanding the Tax Characteristics of Your Investments10.2.1. Considering the tax efficiency (or inefficiency) of your investments10.2.2. Knowing where to locate investments based on tax characteristics10.3. Going through the Asset Location Exercise
11. Monitoring Your Portfolio: Rebalancing and Other Smart Strategies
11.1. Rebalancing Your Portfolio11.1.1. Dealing with portfolio drift11.1.1.1. Defining portfolio drift11.1.1.2. Catching the (portfolio) drift11.1.2. Rebalancing back to target11.1.3. Rebalancing close to target11.1.4. Using a working layer of exchange-traded funds11.2. Keeping Tabs on Your Securities11.2.1. Knowing when to hold 'em and when to fold 'em11.2.2. Taking some winnings off the table11.2.3. Setting your security guidelines early11.3. Making Smart Tax Choices11.3.1. Paying attention to taxable gains and losses11.3.2. Deferring and offsetting taxable gains11.3.3. Harvesting tax loss opportunities with exchange-traded funds
12. Measuring Your Results
12.1. Figuring Your Investment Return12.1.1. Calculating your return12.1.1.1. Paying attention to principal12.1.1.2. Coming to terms with term12.1.2. Determining the return that's most meaningful to you12.1.3. Recognizing that making money isn't necessarily the same as doing well12.2. Comparing Your Return to Relevant Benchmarks12.2.1. Knowing which indexes to use, and how to use them12.2.1.1. Selecting and using a benchmark for comparison12.2.1.2. Understanding why benchmark comparisons are useful: Risk and opportunity cost12.2.2. Blending benchmark indexes12.3. Tracking Your Progress against Your Long-Term Plan12.3.1. Determining suitability with a little common sense12.3.2. Determining suitability with a Lifetime Cash-flow Projection
IV. Going beyond the Basics
13. Walking to the Beat of a Different Drum: Opting for Alternative Investments
13.1. Identifying Investment Alternatives13.1.1. Regarding real estate13.1.1.1. Residential versus commercial13.1.1.2. Real estate investment trusts13.1.2. Harboring hard assets13.1.2.1. Commodities13.1.2.2. Commodity investment vehicles13.1.3. Holding hedge funds13.1.3.1. Hedge-fund strategies13.1.3.2. Funds of funds13.1.3.3. Hedge-fund fees13.1.4. Exploring more exotic choices13.1.4.1. Art and collectibles13.1.4.2. Derivatives13.1.4.3. Structured notes13.1.4.4. Limited partnerships13.1.4.5. Private placements13.2. Tapping the Power of Investments That Zig when Others Zag13.3. Deciding When to Go Alternative13.3.1. Hanging on for the alternative investment ride13.3.2. Paying enough attention to alternatives
14. Managing Your Taxes like a Pro
14.1. Playing It Smart When Selling Securities14.1.1. Identifying the information you need14.1.1.1. Cost basis14.1.1.2. Purchase date14.1.2. Figuring the tax implications of your transactions14.2. Locating Your Assets Properly14.2.1. Understanding tax-advantaged accounts14.2.2. Considering an asset location example14.3. Harvesting Tax Losses14.3.1. Staying alert to tax-loss opportunities14.3.2. Using exchange-traded fund swaps to harvest tax losses14.3.3. Keeping clean when it comes to wash sales14.4. Tax Sensitivity: Good in Small Doses
15. Knowing When to Revise Your Plan
15.1. Identifying Life Events That Should Trigger a Review15.1.1. Gradual life changes15.1.1.1. Aging15.1.1.2. Deteriorating health15.1.2. Sudden life changes15.1.2.1. Birth15.1.2.2. Death15.1.2.3. Marriage15.1.2.4. Divorce15.1.2.5. Sudden illness15.1.2.6. Job changes, unexpected dilemmas, and windfalls15.2. Keeping Your Eye on the Economy15.2.1. Recognizing major economic shifts15.2.2. Paying attention to the business cycle15.3. Considering a Lifetime's Worth of Examples15.3.1. Stage 1: Married 30-something parents15.3.2. Stage 2: Stay-at-home Jane and a hiccup in the economy15.3.3. Stage 3: Failing health and an unexpected windfall15.3.4. Stage 4: A grand gesture for the grandchild
16. Finding Help When You Need It
16.1. Knowing the Right (and Wrong) Reasons to Hire an Advisor16.1.1. The right reasons16.1.1.1. To provide objective advice16.1.1.2. To avoid amateur mistakes16.1.1.3. To help you design and execute your written plan16.1.1.4. To put all the pieces together16.1.2. The wrong reasons16.1.2.1. To "beat the market"16.1.2.2. To avoid making the important decisions yourself16.2. Weighing Your Options for an Advisor16.2.1. Making sense of all those letters after an advisor's name16.2.1.1. For help with taxes or financial planning16.2.1.1.1. CFP16.2.1.1.2. CPA16.2.1.1.3. CPA/PFS16.2.1.2. For help with investments16.2.1.2.1. CFA16.2.1.2.2. RIA16.2.1.2.3. RR16.2.2. Knowing what kind of expertise you need16.3. Asking the Right Questions16.4. Understanding How Advisors Earn Their Income16.4.1. Fee16.4.2. Commission16.4.3. Fee plus commission16.4.4. Performance incentive
V. The Part of Tens
17. Ten Asset Classes and Subclasses and Their Historical Rates of Return
17.1. Cash17.2. Corporate Bonds17.3. Treasury Bonds17.4. Municipal Bonds17.5. Real Estate17.6. Commodities17.7. Large-Cap Stocks17.8. Mid-Cap Stocks17.9. Small-Cap Stocks17.10. Emerging-Market Stocks
18. Ten Common Asset Allocation Mistakes
18.1. Ignoring Asset Allocation in the First Place18.2. Believing That Diversification Is Enough18.3. Forgetting to Rebalance18.4. Not Having a Long-Term Plan18.5. Indulging Your Emotions18.6. Paying Too Much Attention to the Financial Media18.7. Chasing Performance18.8. Thinking You Can Outsmart the Market18.9. Ignoring Taxes18.10. Disrespecting Inflation
19. Ten Questions to Test Your Asset Allocation Know-How
19.1. What's the Best Way to Get Consistently Good Investment Performance?19.2. What's Better: An 8 Percent Return or a 9 Percent Return?19.3. What's the Riskiest Kind of Portfolio?19.4. How Much Variety Should You Include in the Asset Classes You Choose?19.5. What's the Best Way to Rebalance?19.6. When Should You Rebalance Your Portfolio?19.7. When Should You Revisit Your Asset Allocation Plan?19.8. Should You Apply Your Asset Allocation Percentages to Each of Your Investment Accounts?19.9. How Do You Know How Well Your Investments Have Performed?19.10. Where Can You Go for Help with Your Asset Allocation?

Content preview from Asset Allocation For Dummies®

Chapter 11. Monitoring Your Portfolio: Rebalancing and Other Smart Strategies

Designing and building your portfolio isn't the end of the asset allocation recipe we work at perfecting throughout this book. To keep delivering the appetizing portfolio results you desire, you need to do diligent maintenance to make sure your portfolio stays true to your recipe.

Your portfolio should be monitored for several reasons. You may need to replace individual securities that lose their luster. Taxes are always a part of the investing picture, so you can be sure that tax considerations may also dictate some remedial action. And, perhaps most important, your portfolio can drift away from its intended allocation due to the vagaries of the markets and occasionally need to be brought back to target by rebalancing on the right schedule.

In this chapter, we go through a helpful step-by-step rebalancing exercise with our fantastic fictional financial friends John and Jane Doe. We look at the details of how they rebalance their portfolio, so that you can understand how rebalancing can work for you and get you the benefits you deserve. We also show you a few other hands-on strategies, beginning with the importance of keeping tabs on the individual securities you own and always being aware of certain tax-driven opportunities, such as timing the sale ...

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Asset Allocation For Dummies®

by Dorianne Perrucci, Jerry A. Miccolis

Chapter 11. Monitoring Your Portfolio: Rebalancing and Other Smart Strategies

Become an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
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