Why is ‘Asset allocation’ so important?

Tuesday, 29th July 2008 10:04 - by Resident IFA

Not a good start…a title that is heading for article territory. Oh well, it is hard to avoid it sometimes, being a relatively newbie blogger and all. Asset allocation in personal finance terms is how your monies are spread across different asset classes - perhaps in a Pension or Investment product. Now to answer the question: I visited Clients for a yearly review of their Investment portfolio yesterday – a meeting that illustrated the importance of care in asset allocation. Their portfolio had fallen by approximately 5.25%. “Not particularly good!” I hear you cry, but saved from far worse by the inclusion of diversified asset classes. To illustrate this point, when I looked at the FTSE100 performance at the end of last week, the difference between that day (not the lowest point in the last 12 months) and the highest point over the last 12 months was 19.6%. So, a 5.25% loss looks a whole lot better in this context. As well as the FTSE100 dropping like a stone, most UK Equity collective investment funds (i.e. OEICs and Unit Trusts) have had a similar experience, most seeing a reversal of between 15% and 20%. Again, these Clients benefited from good (and timely, as luck would have it) asset allocation in this instance. At the last review in 2007, I recommended they consolidate all their many PEP and ISA holdings, approximately 11 in all, to one investment fund ‘platform’. This action still gave them the choice of around 1,000 funds, but eased the administrative and analysis burden. The over-riding benefit is that the asset allocation I devised, based on their investment risk profiles, had only 20% in UK Equities…compared to the 75% to 80% they had at that point. You can see where this is going – they would have had a much greater loss over the last year without my tailored asset allocation. Let’s hope I can help move their money forward again now… As a final plus-point for asset allocation, the rule of thumb is that it pitches ‘non-correlated’ asset classes within the same portfolio to provide balance and promote positive returns i.e. Property prices have historically risen as Equities have fallen, and vice-versa. With the extraordinary financial goings-on of the last year in the UK, this has almost been made a lie, but generally holds good over time and in ‘normal’ market conditions, whatever they are! Until next time…