Investing without Wall Street: The Five Essentials of Financial Freedom

CHAPTER 1

The First Essential: Determine the Right Asset Allocation

Now let's turn to improving your investing skills.

Chapters 1 and 2 are the most important in this book. To give you an idea how important they are, over 2,500 books and countless magazine and newspaper articles have been written on the subject of how to spread your money among—and within—classes of assets.

Given its fundamental nature you would think that virtually every investor would be well acquainted with the principles of diversification. Yet I find that such is not the case. I continually run across investors who have only the haziest idea of how to correctly implement an asset allocation and diversification strategy. I use a quick test to gauge their competency in this area:

Question: Do you know what percentage of your portfolio is currently invested in equities? Yes, no, without looking it up? If you don't carry that number in your head, you may not be applying whatever you do know correctly.

There is a tendency to ignore diversification, perhaps because it is so basic. And a fair number invest with the belief that they already know it all. But that's not usually the case. So let's start at the beginning.

The Basics

Asset allocation basically means holding various asset classes whose performance is uncorrelated; that is, they fluctuate independently of each other. That's the whole point. If two investments fluctuate in tandem, they won't provide diversification, or reduce risk.

The three most important ...