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By: Deron McCoy, CFA®, CFP®, CAIA, AIF®
Chief Investment Officer

Asset Allocation: Your Portfolio’s North Star

Every individual portfolio needs an intended destination and a road map to guide it. At SEIA, our mission is to provide the straightest and smoothest path possible to your unique destination. Asset allocation is the means by which we accomplish that; allowing us to dial up or dial down portfolio risk to properly align with your stated objectives. 

Together, asset allocation and portfolio construction* serve as a system of checks and balances – seeking to remove a great deal of emotion from the investment decision-making process and forcing you to take profits from strategies that have been working and reallocate those dollars to strategies that have been temporarily out of favor.

Once we’ve helped you to clarify, quantify and prioritize your goals, defined your time horizon and discussed your ability and willingness to take on risk, we formulate a plan that targets an asset allocation designed to achieve those stated goals without exposing the portfolio to additional risk. But asset allocation isn’t solely about getting from point A to point B. It’s also about smoothing out the ride so that you will be able to stick with your portfolio even when markets become turbulent. By bringing together a variety of different investments, we’re better able to potentially offset a great deal of market volatility.

Building and implementing your allocation strategy

Your allocation strategy begins with your goals. If you’re focused on generating 4% after inflation to live a fulfilling life in retirement, you’re going to have a very different portfolio from someone who’s saving for a retirement that is 10-20 years down the road. 

Next comes the “sleep at night” test. A perfectly constructed portfolio that’s geared to delivering an 8-12% annual return achieves nothing if the investor panics and sells when the stock market falls 10%. Volatility is the price investors pay for potentially higher returns. But if it’s inherent in your nature to sell into weakness, then don’t subject yourself to a portfolio that may experience some sort of significant drop every 2-3 years. 

From these two variables, we can identify the right mix of not only stocks, bonds and cash, but also determine what regions, what sectors, or which alternative investments are appropriate for your unique situation based on assets you may already own (e.g., real estate, company stock and private investments). For example, an executive at a Silicon Valley tech firm with significant company stock holdings may benefit from dialing back the exposure to tech stocks in their liquid investment portfolio.

When allocations might shift

At its core, your asset allocation will be determined primarily by the financial goals and risk parameters that your unique circumstances dictate. That’s why we encourage investors to focus more on the variables you can control (your spending/savings habits) rather than on variables that are beyond your control – things like the state of the economy or the stock market. 

As portfolio managers, however, it’s our job to actively reposition investments within each asset class depending on the economic outlook. For instance, the makeup of an income portfolio looks very different if interest rates are below 2% than it does when they are above 6%. By managing allocation shifts within a business cycle we seek to amplify your returns. Look no further than last year’s monetary and fiscal policy changes (e.g., tax cuts, deregulation and trade wars) for an example of why allocation flexibility might be warranted. 

Additionally, allocations will likely need to change as you achieve certain goals and/or as your needs evolve. Allocation shifts might also be required should you wish to have your portfolio better reflect your personal values through a socially responsible investing strategy.

Addressing income needs

Perhaps the most common change to your asset allocation will occur as you transition into retirement – where a lifetime focus on asset accumulation gradually gives way to a new emphasis on tax-efficient income generation. Given the current and expected interest rate environment, income dominates many of our conversations these days – exploring different solutions for different needs and goals. 

For instance, if you need your entire portfolio to be liquid enough that everything could be turned into cash within a few days, then your investment choices will be much more limited than someone who can set aside some money and lock it up for a while. In the latter case, we can potentially generate a much more attractive income stream. But everything other than a 3-month treasury bill** carries some element of risk that you need to be cognizant of and ok with. There’s no such thing as a one-size-fits-all solution. Inevitably the proper asset allocation depends on both your time horizon and liquidity needs.

If you’ve been investing in fixed-rate bonds over the long-term, you’ve likely become accustomed to consistently positive year-over-year returns. Going forward, however, the likelihood of traditional bond portfolios replicating the returns they’ve achieved over the past 20 years is uncertain. Investors need to reset their expectations regarding the bond side of their portfolio – unfixing their income and perhaps considering private vehicles that can generate a different type of income stream.

If there’s one thing that we hope all SEIA clients keep in mind, it’s that asset allocation isn’t something that you set-and-forget. As markets change and, more importantly, your circumstances, goals and life change, your asset allocation strategy also needs to evolve in order to address those new realities.