Reevaluating your financial plan is something that you can do at any time of year, but for most people, it makes sense to schedule a little check-up when the New Year rolls around. That makes it easier to remember when it’s time again. Although there are many aspects of your financial plan that you should go over every year, my suggestion today is for you to take a careful look at your household’s asset allocation.
Asset allocation is what percentage of your money is in each type of investment. Studies have shown that the differences in performance over long periods of investment are primarily a function of asset allocation, as opposed to skill of portfolio managers at selecting the particular investments within each asset group.
If you have retirement accounts, mutual funds, or investments in other financial assets, the company that holds your money will send you a regular statement that tells you how it’s allocated across asset classes. But to correctly assess your overall household portfolio, you need to also consider other kinds of assets–housing equity, investment real estate, family business interests, money market accounts, and regular savings accounts.
And it’s a good idea to break down the stock and bond investments into smaller categories-large company stocks, small company stocks, government bonds, corporate bonds.
Make a list of all of your investments with their respective dollar values. Subtotal the values of any that are in the same category e.g. all bonds or bond mutual funds, all savings and checking accounts, all stocks, all real estate equity. The value of each subtotal over the total of all your assets is your percentage allocation to that asset.
So how much should you have in each category? Although some so-called experts might profess to know the answer to that question (and will tell you for a fee), there really isn’t a one-size-fits-all correct answer.
There are, however, some wrong answers. For example, you shouldn’t have all your money in any one type of asset. That exposes you to entirely too much risk, as many have discovered when the stock market or the real estate market hits a slump and they have nothing else to offset the losses.
It’s also not a good idea to take too little risk. Except in rare cases, you shouldn’t have all your money in savings and checking accounts, because these accounts generally earn so little interest that they don’t even keep up with inflation.
A few rules of thumb that might help:
-Diversify, diversify, diversify. In other words, spread your money around in different asset classes. The losses in one asset class are often offset by gains in another.
-If you need to have access to money in a short amount of time (one year or less), such as college tuition bills or a home down-payment, then it should be in a low risk money market or other interest-bearing savings account.
-If you don’t need the money for a while, you should have at least some of it allocated to stocks. Over time, stock investments have generally outperformed other categories for long-term investors.
-Don’t get too heavily allocated to real estate, particularly when all of it is in the same regional market. In a pinch, real estate is the least liquid asset you own-it’s hard to sell quickly. The real estate market is cyclical, as we’ve seen evidence of recently and it’s even harder to sell in down markets.
By Vickie Bajtelsmit, Professor of Finance
Colorado State University College of Business