Many Styles, Many Sectors
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the Ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
Asset allocation at its simplest refers to the three major asset classes: stocks, real estate and cash. You can subdivide these classes further, however, and add even more diversification to your portfolio.
Stocks, for instance, have multiple subgroups. First, they are either domestic or international – although the proliferation of truly global corporation is beginning to blur the distinction. They can also be categorized by size (market capitalization) or by their style (value versus growth).
Stock categories tend to move in cycles: Large-company stocks outperformed small-company stocks in the latter half of the 1990s, but small company stocks have frequently outperformed their large counterparts. Value stocks (those that appear to be trading at less than their true worth) as a category tend to move in the opposite direction as growth stocks (those that are growing rapidly and are priced at a premium). Over the past 25 years, value and growth have taken turns out-performing each other. Of course, these trends may not continue. As a matter of fact, recently, this has been false.
Asset allocation tells us that most investors ought to have both growth and value stocks in their portfolio, for diversification’s sake. It doesn’t give guidance, however, on what percentage of each style ought to be in your own portfolio. That depends on your personal goals and risk tolerance.
Most importantly, asset allocation can help you form a plan. In the current investment climate, it’s easy to be sidetracked by the media buzz about what’s hot and what’s not. If your own plan sufficiently spreads your assets among various styles and sectors, you have a good chance that you will participate when one of the hot sectors shoots upwards, and be less traumatized when one of the sectors takes a dive.
Four Steps to a Sensible Portfolio
If you’re convinced by the common sense of asset allocation, how do you get started? Four basic steps will help you construct a portfolio that works for you.
The first step of the asset allocation process is constructing an objective and thorough financial profile – your assets, your liabilities, your future goals and the various time horizons to each of those goals. Your family situation, children’s education, weddings and other important events should be taken into consideration. The next step is to seriously gauge your tolerance for risk. Remember that investors commonly overstate their risk tolerance while markets are good and understate their risk tolerance when markets are down.
Smart investing doesn’t happen by itself. It requires planning, monitoring and occasional fine-tuning.
Once you’ve determined your goals and your risk tolerance, you can construct the asset allocation mix most suitable to your needs. The construction of your portfolio will consequently reflect who you are, the goals you want to reach, and how best to reach them in the allotted time.
The fourth step: On a regular basis – at least once a year – you should review and rebalance your portfolio. Are the allocations still aligned with your plan? Have your goals changed? Whenever specific goals are reached – such as the financing of a child’s higher education, weddings, responsibilities to parents and other commitments – you should review your portfolio and adjust it in accordance with your new circumstances.
Finally, remember that smart investing doesn’t happen by itself. It requires planning, monitoring, and occasional fine-tuning. Asset allocation provides the foundation.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, nor does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr Aslam does not have anything for sale.)