Asset allocation is an important investment principle that I incorporate into my overall investment map. It’s important primarily because cheap stocks, asset classes or companies can always get cheaper after you have initially purchased them.
Many folks budget their weekly income but I have seen many investors fail to undertake asset allocation (which is budgeting) with their investments. You should never assume a stock will rise once you have bought it.
I have also found that good money management via asset allocation can reduce any stress or concerns I have if the investment purchase drops after being bought. It is somewhat psychologically reassuring that as your stock falls you have a cash reserve which allows you to buy more as the price declines. While this can seem irrational, you are actually getting more stocks at a cheaper price.
No-one has the skill to buy the bottom on a regular basis, so it make sense to keep some spare cash.
For those of you thinking, “gee maybe you have a dud investment so more funds might not be a great idea”. Ok, but seldom do asset classes (such as Sectors, Countries or Styles) stay low forever (See my paper on mean reversion). Also a study called Doubling Down showed that fund managers who “doubled down” on their investments outperformed those who sold too early (https://alphaarchitect.com/2014/11/17/does-doubling-down-work/)
Another reason for appropriate asset allocation is that markets fluctuate. Have a look at the intra-year fluctuations of the ASX200.
You can see that “buying the dip” is generally a good idea since markets rise most of the time. So spare cash gives you a greater range of options to BTD. There is no “correct” asset allocation. While diversification is important, a large portion of your investment success can be simply choosing the right asset class at the right time. Note how the various asset classes in and out of favour. This is a great example of my other papers – mean reversion, and buy low, sell high.
Closer to home, astute asset allocation is aptly demonstrated by Australian residential property in Sydney and Melbourne booming while the ASX 300 meandered back and forth.
Steve, my coach told me how he bought a property at New Farm for $175,000 and sold it 8 years later for $326,000. I replied that was an astute investment decision. He said, “truth is, I bought it because it was near my friends who recommended it and also it was close to the city where I worked”. No genius just luck and being in the right asset class. So how do we allocate astutely across asset classes? An example:
You can invest across asset classes so when allocating funds (say using Country and Sector ETF’s) it is generally best to do it proportionately. Why? Because while some investment will be more appealing and appear to have more potential, the fact is that you can’t be sure and so the best approach it to allocate the same portion.
Buffett’s number one rule is “Don’t lose money”. Having a set of investment principles that include a disciplined approach to asset allocation will certainly increase the probability that your investments will adhere to Buffett’s number one rule.