Diversification and Asset Allocation

     Events and emotions of the overall market probably have more  influence on a stock’s price movement than the fundamentals of the stock itself. An investor can help his overall returns on his portfolio with diversification and asset allocation.  

     Diversification is dividing your portfolio into equal unit amounts and putting those units into different sectors of the market. For example: 3 units; 1 into a retail stock, 1 into an energy stock and 1 into an industrial stock. By diversifying, you’re likely to have more stable portfolio growth over time as one stock goes down and another goes up.

     Asset allocation is dividing your portfolio into different asset classes like stocks, bonds and cash.   Asset allocations should be   based  on personal objectives, temperament as well as market and economic conditions.

     Beginners and smaller portfolios should start with the basic 3-equities, bond and cash. As your portfolio increases and you gain more experience and confidence, you could increase asset classes like international, REITs or gold.  There are many ways to allocate, you should experiment to find which is most profitable and comfortable for you.

Asset Allocation and Rising or Topping Markets

      Asset allocation helps you with the first rule of compounding: Minimize your losses. In a growing economy and rising markets, you don’t really need to be concerned with losses because the market is more likely to go up than down. This is the part of the cycle where you get higher high and higher lows. This is part of the cycle where speculation can be quite profitable. The rising market part of the cycle where capital appreciation can be the primary objective while capital gains are second and income last.

An allocation example for this part of the cycle could 10% in bonds, 5% in cash, 85% in stocks.

     As the economy tops usually with Federal Reserve raising interest rates 3 times, preserving the gains from the rising market becomes the primary objective. 

An allocation example could be, 20% bonds, 40% in cash, 40 % in stocks.

      As risks and speculation rise, it is time to lessen your exposure by selling stocks and going into cash or bonds.

Asset Allocation and Falling or Basing Markets

     A few months after the Federal Reserve raises rates, the economy usually declines. The markets usually anticipate the decline and falls before the economy. 

An allocation example here could be 30% bonds, 30% cash, 40% in stocks.

     Bad economic news and falling markets continue. At some point bears show up on the cover of news magazines and say the markets aren’t likely to go up again. When you see the bears on the magazines, the Fed lowers rates at least 3 times and the markets begin building bases, it’s time to sell bonds and start accumulating increasing dividend paying stocks. 

An allocation example for here could be 15% bonds, 25% cash, 60%  in stocks.

     As economic growth becomes more visible and stronger, you could sell all bonds and most of the cash and put them in trading stocks. This is the area to buy good quality dividend increasing stocks that  have yields that beat inflation over time.