What Does Asset Allocation Mean?

An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets
according to an individual's goals, risk tolerance and investment horizon.

The three main asset classes - equities, fixed-income, and cash and equivalents - have different
levels of risk and return, so each will behave differently over time.

Investopedia explains Asset Allocation

There is no simple formula that can find the right asset allocation for every individual. However,
the consensus among most financial professionals is that asset allocation is one of the most
important decisions that investors make. In other words, your selection of individual securities is
secondary to the way you allocate your investment in stocks, bonds, and cash and equivalents,
which will be the principal determinants of your investment results.

Asset-allocation mutual funds, also known as life-cycle, or target-date, funds, are an attempt to
provide investors with portfolio structures that address an investor's age, risk appetite and
investment objectives with an appropriate apportionment of asset classes. However, critics of this
approach point out that arriving at a standardized solution for allocating portfolio assets is
problematic because individual investors require individual solutions

A portfolio strategy that involves periodically rebalancing the portfolio in order to maintain a long-
term goal for asset allocation.

Investopedia explains Strategic Asset Allocation

At the inception of the portfolio, a "base policy mix" is established based on expected returns.
Because the value of assets can change given market conditions, the portfolio constantly needs
to be re-adjusted to meet the policy

What Does Tactical Asset Allocation - TAA Mean?

An active management portfolio strategy that rebalances the percentage of assets held in various
categories in order to take advantage of market pricing anomalies or strong market sectors.

Investopedia explains Tactical Asset Allocation - TAA

This strategy allows portfolio managers to create extra value by taking advantage of certain
situations in the marketplace. It is as a moderately active strategy since managers return to the
portfolio's original strategic asset mix when desired short-term profits are achieved
Asset allocation is the strategy an investor uses to distribute his or her investments
among various classes of investment vehicles (e.g., stocks and bonds).

A large part of financial planning is finding an asset allocation that is appropriate for a
given person in terms of their appetite for and ability to shoulder risk. This can depend on
various factors; see investor profile

Asset allocation is based on the idea that in different years a different asset is the best-
performing one. It is difficult to predict which asset will perform best in a given year.
Thus, although it is psychically appealing to try to predict the "best" asset, proponents of
asset allocation consider it risky. They say that someone who "jumps" from the one asset
to another, according to whim, may easily end up with worse results than any consistent
plan.

A fundamental justification for asset allocation is the notion that different asset classes
offer returns that are not perfectly correlated, hence diversification reduces the overall
risk in terms of the variability of returns for a given level of expected return. Therefore
having a mixture of asset classes is more likely to meet the investor's goals.

In this respect, diversification has been described as "the only free lunch you will find in
the investment game." Academic research has painstakingly explained the importance of
asset allocation and the problems of active management (see academics section, below).
This explains the steadily rising popularity of passive investment styles using index
funds.

Although risk is reduced as long as correlations are not perfect, it is typically forecast
(wholly or in part) based on statistical relationships (like correlation and variance) that
existed over some historical period. Expectations for return are often derived in the same
way.

When such backward-looking approaches are used to forecast forward-looking inputs for
return or risk in the traditional mean-variance optimization approach to asset allocation
(MVO being the central tenet of Modern Portfolio Theory), the strategy may merely wind
up expressing expecations for risk and return in historical terms. As there is no guarantee
that past relationships will continue in the future, this is one of the "weak links" in
traditional asset allocation strategies as derived from MPT. Other, more subtle
weaknesses include the "butterfly effect," by which seemingly minor errors in forecasting
lead to recommended allocations that are grossly skewed from investment mandates
and/or impractical -- often even violating an investment manager's "common sense"
understanding of a tenable portfolio-allocation strategy.
[edit] Examples of asset classes
Wikibooks has more on the topic of
Asset allocation

• cash (i.e., money market accounts)

• Bonds: investment grade or junk (high yield); government or corporate; short-
term, intermediate, long-term; domestic, foreign, emerging markets
• stocks: value or growth; large-cap versus small-cap; domestic, foreign, emerging
markets
• real estate
• foreign currency
• natural resources
• precious metals
• luxury collectables such as art, fine wine and automobiles

To further break down equity investments into additional asset classes consider the
following:

• By size:

Large-Cap
Mid-Cap
Small-Cap

• By style:

Growth
Blend
Value

• REITs
• International Investments: foreign or emerging markets
• Life settlements

Note that 'funds' are not an asset class; funds are filed under what they own, e.g. stocks
for stock funds, bonds for bond funds
Return versus risk trade-off
In asset allocation planning, the decision on the amount of stocks versus bonds in one's
portfolio is a very important decision. Simply buying stocks without regard of a possible
bear market can result in panic selling later. One's true risk tolerance can be hard to gauge
until having experienced a real bear market with money invested in the market. Finding
the proper balance is key

Achieving Optimal Asset Allocation

by Shauna Carther (Contact Author | Biography)
Email Article

Print

Comments

Reprints

The important task of appropriately allocating your available investment funds among different
assets classes can seem daunting, with so many securities to choose from. Here we will illustrate
what asset allocation is, its importance and how you can determine your appropriate asset mix
and maintain it.

What is Asset Allocation?

Asset allocation refers to the strategy of
dividing your total investment portfolio among
various asset classes, such as stocks, bonds
and money market securities. Essentially, asset allocation is an organized and effective method of
diversification.

To help determine which securities, asset classes and subclasses are optimal for your portfolio,
let's define some briefly:

• Large-cap stock - These are shares issued by large companies with a market
capitalization generally greater than $10 billion.
• Mid-cap stock - These are issued by mid-sized companies with a market cap generally
between $2 billion and $10 billion.
• Small-cap stocks - These represent smaller-sized companies with a market cap of less
than $2 billion. These types of equities tend to have the highest risk due to lower liquidity.
 • International securities - These types of assets are issued by foreign companies and
listed on a foreign exchange. International securities allow an investor to diversify outside
of his or her country, but they also have exposure to country risk - the risk that a country
will not be able to honor its financial commitments.
• Emerging markets - This category represents securities from the financial markets of a
developing country. Although investments in emerging markets offer a higher potential
return, there is also higher risk, often due to political instability, country risk and lower
liquidity. (For further reading, see What Is An Emerging Market Economy?)
• Fixed-income securities - The fixed-income asset class comprises debt securities that
pay the holder a set amount of interest, periodically or at maturity, as well as the return
of principal when the security matures. These securities tend to have lower volatility than
equities, and have lower risk because of the steady income they provide. Note that
though payment of income is promised by the issuer, there is a risk of default. Fixed-
income securities include corporate and government bonds.
• Money market - Money market securities are debt securities that are extremely liquid
investments with maturities of less than one year. Treasury bills (T-bills) make up the
majority of these types of securities.
• Real-estate investment trusts (REITs) - Real estate investment trusts (REITs) trade
similarly to equities, except the underlying asset is a share of a pool of mortgages or
properties, rather than ownership of a company.

Maximizing Return While Minimizing Risk

The main goal of allocating your assets among various asset classes is to maximize return for
your chosen level of risk, or stated another way, to minimize risk given a certain expected level of
return. Of course to maximize return and minimize risk, you need to know the risk-return
characteristics of the various asset classes. Figure 1 compares the risk and potential return of
some of the more popular ones:

Figure 1

Equities have the highest potential return, but also the highest risk. On the other hand, Treasury
bills have the lowest risk since they are backed by the government, but they also provide the
lowest potential return.
Figure 1 also demonstrates that when you choose investments with higher risk, your expected
returns also increase proportionately. But this is simply the result of the risk-return tradeoff. They
will often have high volatility and are therefore suited for investors who have a high risk tolerance
(can stomach wide fluctuations in value), and who have a longer time horizon.

It's because of the risk-return tradeoff - which says you can seek high returns only if you are
willing to take losses - that diversification through asset allocation is important. Since different
assets have varying risks and experience different market fluctuations, proper asset allocation
insulates your entire portfolio from the ups and downs of one single class of securities. So, while
part of your portfolio may contain more volatile securities - which you've chosen for their potential
of higher returns - the other part of your portfolio devoted to other assets remains stable. Because
of the protection it offers, asset allocation is the key to maximizing returns while minimizing risk.

Deciding What's Right for You

As each asset class has varying levels of return for a certain risk, your risk tolerance, investment
objectives, time horizon and available capital will provide the basis for the asset composition of
your portfolio.

To make the asset allocation process easier for clients, many investment companies create a
series of model portfolios, each comprising different proportions of asset classes. These portfolios
of different proportions satisfy a particular level of investor risk tolerance. In general, these model
portfolios range from conservative to very aggressive:

Conservative model portfolios generally allocate a large percent of the total portfolio to lower-risk
securities such as fixed-income and money market securities.

The main goal with a conservative portfolio is to protect the principal value of your portfolio. As
such, these models are often referred to as "capital preservation portfolios".
Even if you are very conservative and prefer to avoid the stock market entirely, some exposure
can help offset inflation. You could invest the equity portion in high-quality blue chip companies,
or an index fund, since the goal is not to beat the market. (For further reading, see the tutorial All
about Inflation.)

A moderately conservative portfolio is ideal for those who wish to preserve a large portion of the
portfolio’s total value, but are willing to take on a higher amount of risk to get some inflation
protection.

A common strategy within this risk level is called "current income". With this strategy, you chose
securities that pay a high level of dividends or coupon payments.

Moderately aggressive model portfolios are often referred to as "balanced portfolios" since the
asset composition is divided almost equally between fixed-income securities and equities in order
to provide a balance of growth and income.

Since these moderately aggressive portfolios have a higher level of risk than those conservative
portfolios mentioned above, select this strategy only if you have a longer time horizon (generally
more than five years), and have a medium level of risk tolerance.

Aggressive portfolios mainly consist of equities, so these portfolios' value tends to fluctuate
widely. If you have an aggressive portfolio, your main goal is to obtain long-term growth of capital.
As such the strategy of an aggressive portfolio is often called a "capital growth" strategy.
To provide some diversification, investors with aggressive portfolios usually add some fixed-
income securities.

Very aggressive portfolios consist almost entirely of equities. As such, with a very aggressive
portfolio, your main goal is aggressive capital growth over a long time horizon.

Since these portfolios carry a considerable amount of risk, the value of the portfolio will vary
widely in the short term.

Nothing is Set in Stone

Note that the above outline of model portfolios and the associated strategies offer only a loose
guideline - you can modify the proportions above to suit your own individual investment
needs. How you fine tune the models above can depend on your future needs for capital and on
what kind of an investor you are. For instance, if you like to research your own companies and
devote time to stock picking, you will likely further divide your equities portion of your portfolio
among subclasses of stocks. By doing so, you can achieve a specialized risk-return potential
within one portion of your portfolio. (For further reading, see the tutorial Guide to Stock-Picking
Strategies.)

Also, the amount of cash and equivalents, or money market instruments you place in your
portfolio will depend on the amount of liquidity and safety you need. If you need investments that
can be liquidated quickly or you would like to maintain the current value of your portfolio, you
might want to put a larger portion of your investment portfolio in money market or short-term
fixed-income securities. Those investors who do not have liquidity concerns and have a higher
risk tolerance will have a small portion of their portfolio within these instruments.

Maintaining Your Portfolio

Once you have chosen your portfolio investment strategy, it is important to conduct periodic
portfolio reviews, as the value of the various assets within your portfolio will change, affecting
the weighting of each asset class. For example, if you start with a moderately conservative
portfolio, the value of the equity portion may increase significantly during the year, making your
portfolio more like that of an investor practicing a balanced portfolio strategy, which is higher risk!

In order to reset your portfolio back to its original state, you need to rebalance your portfolio.
Rebalancing is the process of selling portions of your portfolio that have increased significantly,
and using those funds to purchase additional units of assets that have declined slightly
or increased at a lesser rate. This process is also important if your investment strategy or
tolerance for risk has changed.

Conclusion
Asset allocation is a fundamental investing principle, because it helps investors maximize profits
while minimizing risk. The different asset allocation strategies described above can help any
investor do this regardless of their risk tolerance and investment goals. In turn, choosing an
appropriate asset allocation strategy and conducting periodic reviews will ensure you maintain
your long-term investment goals and reach your desired return at the lowest amount of risk
possible.
Choose Your Own Asset Allocation Adventure/strategies
Portfolio construction starts after the investment advisor and investor formulate a realistic
investment objective or spending plan. Only then can real portfolio magic occur. In this article,
we'll break down four different ways to allocate the assets in your portfolio to help keep your
investments balanced and growing. (To find out how to build your portfolio, see A Guide To
Portfolio Construction, Portfolio Protection In Diversification And Discipline and Introduction To
Diversification.)

1. Strategic Asset Allocation

Once the investment objective or spending plan is complete, the asset mix for strategic asset
allocation generally adheres to the expected performance of asset classes. Given the long-term
nature of investment objective constraints, the investment advisor will develop a long-term
forecast. (To keep reading about asset allocation, see Achieving Optimal Asset Allocation and
Asset Allocation Strategies.)

A range of forecasting methods exist, but a simple and popular method relies on mean reversion,
where the asset class's performance tends to converge to the average long-term performance. A
more precise method relies on using long-term forecasts of important economic
variables, particularly inflation, as these can dramatically affect future wealth and spending.

For example, if the inflation rate is

expected to be higher than generally
anticipated, the allocation would tend
toward inflation hedging and lean
more toward stocks and commodities
such as gold, but away from fixed-
income instruments, unless they carry
inflation protection (such as inflation-
linked bonds). Within an asset class
like bonds, allocation would favor
those in which the prices are less
sensitive to the long-term effects of
inflation. (Find out more about inflation
in All About Inflation, Curbing The
Effects Of Inflation and The Forgotten
Problem Of Inflation.)

The following should make clear that it

is within the stock allocation, if good economic growth with low inflation are expected in the stock
market, the allocation would favor growth over value stocks, as this situation reduces downside
uncertainty and encourages investors to place more weight on profits in the more distant future.
Furthermore, small-cap stocks, on average, tend to be favored over large-cap stocks. This is
because a growth orientated situation tends to allow small-cap companies to grow at a faster rate
relative to their larger-cap counterparts.

Because the ultimate goal of asset allocation is to create a unique and customized portfolio of
assets from the optimal combination of disparate investments, correlations between those asset
classes must also be considered when deriving the final weights. These factors measure how
diversified the constituent asset classes are and measures how similar asset classes perform
over the investment horizon that is under consideration. Investors strive to allocate capital to
create a strategic allocation in which each component has a low average correlation to another in
the portfolio.

In general, the process can also be described as the optimal solution for an asset and liability
problem. The liability can be defined as a scheduled cash outlay, minimum total return target,
maximum sharpe ratio, a minimum tracking error (if the investment mandate is to outperform a
benchmark) or some combination of the above.

2. Tactical Asset Allocation

The tactical asset allocation strategy forms a portfolio that deviates from the strategically
determined long-term, optimal portfolio. Both the opportunity and motivation arise from the market
participants' independent assessment of fair value and how it differs from the market consensus.
Successfully capitalizing on this strategy often requires an information advantage relative to the
rest of the market. This often requires raw information as well as the superior ability to interpret
that information. This is the value some investors can add through the ability to build critical
relationships, and it is particularly important when the investment opportunity consists of
securities in the less developed markets, such as emerging market stocks. (For related reading,
see What Is An Emerging Market Economy?)

The implied fair value is generally derived from asset prices using methods that can range from
the fairly simple to the very intricate.

In the fixed-income asset class, especially in the shorter maturity tenors, investors measure the
implied forward yield to determine how the market or consensus differs from their own in
anticipating future movements in short-term interest rates.

For example, if the implied 3x3 forward yield (or the three-month yield, three months into the
future) on a bill is lower than the level the investor expects, then, assuming the investor is correct,
rather than investing in a six-month bill, it is more profitable to invest in two consecutive three-
month bills. This type of analysis can be extended to longer tenor fixed-income instruments, but
with consideration given to the further complications that arise from factors such as convexity
bias.

In the equity markets, investors often reference relative valuation metrics, such as the price-to-
book ratio or price-to-earnings ratio - among many others - to capitalize on short-term trading
opportunities. The calculations can be used to rotate within and across asset classes.

Within the fixed-income asset class, an attractive relative valuation at the shorter end of the yield
curve can be capitalized on by tactically reducing the duration exposure relative to the strategic
level of duration exposure in the asset allocation.

Within equities, more compelling price-to-book ratio deviations versus price-to-earning ratio
deviations can be capitalized on by tactically allocating more investments to growth stocks versus
value stocks than was strategically determined. Similar types of relative comparisons can be
conducted on other important valuation determinants, like implied earnings growth for stocks.

3. Constant Weighted Allocation

A comparison of the payoff profile versus a buy-and-hold strategy (the strategic asset allocation)
provides a good illustration of its properties. The buy-and-hold strategy has a linear payoff to the
performance of the stock market, whereas the constant weighted allocation strategy does not.

In this strategy, the payoff is slightly concave (limited upside) as one sells into an upward market
in the process of rebalancing the portfolio. This strategy is also helped by market reversals as
opposed to a trending market. Volatility helps as well; when the market returns to its starting
value, the strategy profits while a pure buy-and-hold yields a zero return. However, if the market
continues to increase, the buy-and-hold will outperform. The payoff of this strategy is path
dependent as opposed to a buy-and-hold strategy, which only depends on final value. See the
comparison between constant mix and buy-and-hold strategies below.

Figure 1

4. Insured Asset Allocation

This is a type of dynamic asset allocation strategy where the payoff is convex (limited downside)
as one buys into an upward market. The strategy uses a formula-based rebalancing mechanism.
Unlike the constant weighted strategy, this strategy is hurt by market reversals. A strategy that
falls under this category is CPPI (constant proportion portfolio insurance) - see Figure 2 and
Figure 3 below. The rules used to implement this strategy are defined by the following formulas,
as illustrated for a portfolio consisting of only stocks and risk-free bills:

Stock investment = M x (Asset - Floor); M > 1

M is a multiplier which determines the amount of
leverage.

Buy-and-hold is a special case where the multiplier is 1.

Constant weighted allocation is special case where floor
is 0 and the multiplier is between 0 and 1.

As an example, with an initial portfolio of $1,000, if the floor is defined as $700 and M=2, the
initial stock investment is $600.
 Figure 2

Figure 3

Above the floor, investment is actively allocated between stocks and risk-free bills. But at or
below the floor, the portfolio is fully invested in risk-free bills. Rather than actually buying stocks,
the exposure can also be attained by an overlay strategy that uses derivatives such as index
futures and options with the remaining capital held in risk-free bills.

Conclusion
Because the ultimate goal of asset allocation is to create a unique and customized portfolio of
assets, you need to find the allocation strategy that suits your goals. Compare your needs with
each of these techniques, and see which one will allow your portfolio to prosper .

Importance of Mutual fund

FInnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnDDDD
DDDDDDDDDDDDDDDDDDDDDBN

iiiiiiiiiiiiiiii

eaturIMPORTANCE ed Article

Proprietary Mutual Funds: What’s A Label Worth?

Mutual funds are a great way for investing novices to get into the market; they're simple, but that
doesn't mean they can be chosen at random. If you're ready to get your money into a profit-
producing fund, we'll show you everything you need to find one. Read

Picking The Right Mutual Fund

by Glenn Curtis (Contact Author | Biography)
Email Article

Print

Comments

Reprints

Are you thinking about investing in a mutual fund, but aren't sure how to go about it or which one
is the most appropriate based on your needs? You're not alone. However, what you may not know
is that the selection process is much easier than you think.

Read on for some guidelines on how to pick a mutual fund.

Identifying Goals and Risk Tolerance

Before acquiring shares in any fund, an investor must first identify his or her goals and desires for
the money being invested. Are long-term capital gains desired, or is a current income preferred?
Will the money be used to pay for college
expenses, or to supplement a retirement that
is decades away? Identifying a goal is
important because it will enable you to
dramatically whittle down the list of the more
than 8,000 mutual funds in the public domain.

In addition, investors must also consider the issue of risk tolerance. Is the investor able to afford
and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment
warranted? Identifying risk tolerance is as important as identifying a goal. After all, what good is
an investment if the investor has trouble sleeping at night? (For more insight, see Determining
Risk And The Risk Pyramid and A Guide To Portfolio Construction.)

Finally, the issue of time horizon must be addressed. Investors must think about how long they
can afford to tie up their money, or if they anticipate any liquidity concerns in the near future. This
is because mutual funds have sales charges, that can take a big bite out of an investor's return
over short periods of time. Ideally, mutual fund holders should have an investment horizon with at
least five years or more. (For related reading, see Disadvantages Of Mutual Funds.)

Style and Fund Type

If the investor intends to use the money in the fund for a longer term need and is willing to
assume a fair amount of risk and volatility, then the style/objective he or she may be suited for is
a long-term capital appreciation fund. These types of funds typically hold a high percentage of
their assets in common stocks, and are therefore considered to be volatile in nature. They also
carry the potential for a large reward over time.

Conversely, if the investor is in need of current income, he or she should acquire shares in an
income fund. Government and corporate debt are the two of the more common holdings in an
income fund.

Of course, there are times when an investor has a longer term need, but is unwilling or unable to
assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds,
may be the best alternative.

Charges and Fees

Mutual funds make their money by charging fees to the investor. It is important to gain an
understanding of the different types of fees that you may face when purchasing an investment.
Some funds charge a sales fee known as a load fee, which will either be charged upon initial
investment or upon sale of the investment. A front-end load/fee is paid out of the initial investment
made by the investor while a back-end load/fee is charged when an investor sells his or her
investment, usually prior to a set time period, such as seven years from purchase.

Both front- and back-end loaded funds typically charge 3-6% of the total amount invested or
distributed, but this number can be as much as 8.5% by law. Its purpose is to discourage turnover
and to cover any administrative charges associated with the investment. Depending on the
mutual fund, the fees may go to a broker for selling the mutual fund or to the fund itself, which
may result in lower administration fees later on.

To avoid these sales fees, look for no-load funds, which don't charge a front- or back-end
load/fee. However, be aware of the other fees in a no-load fund, such as the
management expense ratio and other administration fees, as they may be very high.

Still other funds charge 12b-1 fees, which are baked into the share price and are used by the fund
for promotions, sales and other activities related to the distribution of fund shares. These fees
come right off of the reported share price at a predetermined point in time. As a result, investors
may not be aware of the fee at all. 12b-1 fees can, by law, be as much as 0.75% of a fund's
average assets per year.

One final tip when perusing mutual fund sales literature: The investor should look for the
management expense ratio. In fact, that one number can help clear up any and all confusion as it
relates to sales charges. The ratio is simply the total percentage of fund assets that are being
charged to cover fund expenses. The higher the ratio, the lower the investor's return will be at the
end of the year.

Evaluating Managers/Past Results

As with all investments, investors should research a fund's past results. To that end, the following
is a list of questions that perspective investors should ask themselves when reviewing the
historical record:

• Did the fund manager deliver results that were consistent with general market returns?
• Was the fund more volatile than the big indexes (meaning did its returns vary dramatically
throughout the year)?
• Was there an unusually high turnover (which can result in larger tax liabilities for the
investor)?

This information is important because it will give the investor insight into how the portfolio
manager performs under certain conditions, as well as what historically has been the trend in
terms of turnover and return.

With that in mind, past performance is no guarantee of future results. For this reason, prior to
buying into a fund, it makes sense to review the investment company's literature to look for
information about anticipated trends in the market in the years ahead. In most cases, a candid
fund manager will give the investor some sense of the prospects for the fund and/or its holdings
in the year(s) ahead as well as discuss general industry trends which may be helpful. (For more
insight, see Digging Deeper: The Mutual Fund Prospectus.)

Size of the Fund

Typically, the size of a fund does not hinder its ability to meet its investment objectives. However,
there are times when a fund can get too big. A perfect example is Fidelity's Magellan Fund. Back
in 1999 the fund topped $100 billion in assets, and for the first time, it was forced to change its
investment process to accommodate the large daily (money) inflows. Instead of being nimble and
buying small and mid cap stocks, it shifted its focus primarily toward larger capitalization growth
stocks. As a result, its performance has suffered. (To learn more, check out Does Size Really
Matter?)

So how big is too big? There are no benchmarks that are set in stone, but that $100 billion mark
certainly makes it difficult for a fund manager to acquire a position in a stock and dispose of it
without running up the stock dramatically on the way up, and depressing it on the way down. It
also makes the process of buying and selling stocks with any kind of anonymity almost
impossible.

Bottom Line
Selecting a mutual fund may seem like a daunting task, but knowing your objectives and risk
tolerance is half the battle. If you follow this bit of due diligence before selecting a fund, you will
increase your chances of success.

Choosing Quality Mutual Funds

By Richard Loth (Contact | Biography)
Printer friendly version (PDF format)
The complexities of the investment process are often beyond the grasp of the general public. For
many people, multiple competing interests and increasingly busy lifestyles leave little opportunity
for learning the basics of investing. Nevertheless, saving and investing for one's future financial
security has to be considered one of life's priorities.

Millions of investors in the U.S. and abroad are using mutual funds as their investment vehicle of
choice to save for college educations, the purchase of a home and for building a retirement nest
egg. Whatever the objective, the mutual fund is an excellent medium to accumulate financial
assets and grow them over time to achieve any of these goals.

However, the task of selecting quality mutual funds is a daunting one. There are far too many
choices, and information overload is a serious problem. In addition, the tactics used in marketing
funds are generally more confusing than enlightening - the unfamiliar jargon and technical
investing concepts can be challenging, to say the least.

Whether you are a do-it-yourselfer, a client of an investment professional, or a participant in a

self-directed retirement plan, you'll need a set of mutual fund evaluative tools that make sense
and are easy to use. Here, we'll attempt to make fund selection and monitoring as simple as
possible, allowing you to make informed decisions and ask the right questions when it comes to
choosing a mutual fund investment.

1) Scoring Fund Investment Quality

- Overview Of The Mutual Fund Industry
- History Of The Mutual Fund
- How A Mutual Fund Works
- Today's Mutual Fund Industry
- Fund Investment Qualities
- Fund Investment Quality Scorecard
2) Sources of Evaluative Data
- Finding Mutual Fund Data
- Morningstar Fund Report
- Value Line Fund Report
- Retirement Plan Documentation and Other Sources
3) A Fund's Investment Objective
- Mutual Fund Categories
- Mutual Fund Style Box
- Fund I-Q No.1: Investing Style
- Scoring Investment Style Data
4) Measuring a Fund's Risk and Return
- Risk-Return Relationship
- Understanding Mutual Fund Returns
- Fund I-Q No.2: Favorable Risk-Return Profiles
- Scoring Risk-Return Data
5) Fund Size and Performance
- Mutual Fund Asset Size
- Fund I-Q No. 3: Size and Style Compatibility
- Scoring Fund Size and Style Data
6) Fund Management Issues
- Passive Vs. Active Management
- Fund I-Q No.4: Manager Tenure and Structure
- Scoring Fund Management Data
7) Fund Transactional Activity
- Portfolio Turnover
- Fund I-Q No. 5: Portfolio Turnover Ratio
- Scoring Fund Turnover Data
8) Fund Costs and Expenses
- Overview Of Mutual Fund Expenses
- Fund I-Q No.6: Costs and Expenses
- Scoring Fund Cost and Expense Data
9) Fund Performance Metrics
- Historical Performance Vs. Underlying Portfolio Characteristics
- Mutual Fund Performance Data
- Fund I-Q No.7: Comparative Total Returns
- Scoring Fund Performance Data
10) Analytical Commentary On a Fund
- Fund I-Q No.8: Favorable Analytics
- Scoring Fund Analytical Commentary
11) Conclusion
- Fund Investment Qualities

IN DETAIL FROM THE SITE.

-

Five Things To Know About Asset Allocation

by Investopedia Staff, (Investopedia.com) (Contact Author | Biography)
Email Article

Print

Comments

Reprints

With literally thousands of stocks, bonds and mutual funds to choose from, picking the right
investments can confuse even the most seasoned investor. However, starting to build a portfolio
with stock picking might be the wrong approach. Instead, you should start by deciding what mix of
stocks, bonds and mutual funds you want to hold - this is referred to as your asset allocation.
What is Asset Allocation?
Asset allocation is an investment portfolio
technique that aims to balance risk and
create diversification by dividing assets
among major categories such as cash,
bonds, stocks, real estate and derivatives.
Each asset class has different levels of
return and risk, so each will behave
differently over time. For instance, while
one asset category increases in value,
another may be decreasing or not
increasing as much. Some critics see this
balance as a settlement for mediocrity,
but for most investors it's the best
protection against major loss should
things ever go amiss in one investment
class or sub-class.

The consensus among most financial professionals is that asset allocation is one of the most
important decisions that investors make. In other words, your selection of stocks or bonds is
secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term
bonds, and to cash on the sidelines.

We must emphasize that there is no simple formula that can find the right asset allocation for
every individual - if there were, we certainly wouldn't be able to explain it in one article. We can,
however, outline five points that we feel are important when thinking about asset allocation:

Risk vs. Return

The risk-return tradeoff is at the core of what asset allocation is all about. It's easy for
everyone to say that they want the highest possible return, but simply choosing the assets
with the highest "potential" (stocks and derivatives) isn't the answer. The crashes of 1929,
1981, 1987, and the more recent declines of 2000-2002 are all examples of times when
investing in only stocks with the highest potential return was not the most prudent plan of
action. It's time to face the truth: every year your returns are going to be beaten by another
investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors
from successful ones is the ability to weigh the difference between risk and return. Yes,
investors with a higher risk tolerance should allocate more money into stocks. But if you can't
keep invested through the short-term fluctuations of a bear market, you should cut your
exposure to equities. (To learn more about bond investing, see Bond Basics Tutorial.

Don't Rely Solely on Financial Software or Planner Sheets

Financial planning software and survey sheets designed by financial advisors or investment
firms can be beneficial, but never rely solely on software or some pre-determined plan. For
example, one rule of thumb that many advisors use to determine the proportion a person
should allocate to stocks is to subtract the person's age from 100. In other words, if you're
35, you should put 65% of your money into stock and the remaining 35% into bonds, real
estate and cash.

But standard worksheets sometimes don't take into account other important information such
as whether or not you are a parent, retiree or spouse. Other times, these worksheets are
based on a set of simple questions that don't capture your financial goals. Remember,
financial institutions love to peg you into a standard plan not because it's best for you, but
because it's easy for them. Rules of thumb and planner sheets can give people a rough
guideline, but don't get boxed into what they tell you.

Determine your Long and Short-Term Goals

 We all have our goals. Whether you aspire to own a yacht or vacation home, to pay for your
child's education, or simply to save up for a new car, you should consider it in your asset
allocation plan. All of these goals need to be considered when determining the right mix.

For example, if you're planning to own a retirement condo on the beach in 20 years, you
need not worry about short-term fluctuations in the stock market. But if you have a child who
will be entering college in five to six years, you may need to tilt your asset allocation to safer
fixed-income investments.

Time is your Best Friend

The U.S. Department of Labor has said that for every 10 years you delay saving for
retirement (or some other long-term goal), you will have to save three times as much each
month to catch up. Having time not only allows you to take advantage of compounding and
the time value of money, it also means you can put more of your portfolio into higher
risk/return investments, namely stocks. A bad couple of years in the stock market will likely
show up as nothing more than an insignificant blip 30 years from now.

Just Do It!
Once you've determined the right mix of stocks, bonds and other investments, it's time to
implement it. The first step is to find out how your current portfolio breaks down. It's fairly
straightforward to see the percentage of assets in stocks vs. bonds, but don't forget to
categorize what type of stocks you own (small, mid, or large cap). You should also
categorize your bonds according to their maturity (short, mid, long-term). Mutual funds can
be more problematic. Fund names don't always tell the entire story. You have to dig deeper
in the prospectus to figure out where fund assets are invested.

There is no one standardized solution for allocating your assets. Individual investors require
individual solutions. Furthermore, if a long-term horizon is something you don't have, don't worry.
It's never too late to get started. It's also never too late to give your existing portfolio a face-lift:
asset allocation is not a one-time event, it's a life-long process of progression and fine-tuning.

Portfolio Management Pays Off In A Tough Market

by Jason Whitby,CFP, CFA, MBA, AIF (Contact Author | Biography)
Email Article

Print

Comments

Reprints

When you think about investing, you have a very long decision tree - the question of passive or
active, long or short, stocks or funds, China or Brazil and on and on. These topics seem to
occupy the majority of the media as well as individuals' minds. However, these decisions are far
down the investing process relative to portfolio management. Portfolio management is basically
looking at the big picture. This is the classic forest and trees analogy; many investors spend too
much time looking at each tree (stock, fund, bond, etc) and not enough - if any - time looking at
the forest (portfolio management).
Prudent portfolio management begins after the client and his or her advisor have reviewed the
total picture and completed an investment policy statement (IPS). Embedded in the IPS is the
asset allocation strategy of which there are four: integrated, strategic, tactical and insured. Most
people recognize how critical asset allocation is, but most investors are unfamiliar with asset
allocation rebalancing strategies, of which there are also four: buy-hold, constant-mix, constant
proportion and option based. A lack
of familiarity with rebalancing
strategies helps explain why many
confuse the constant-mix
rebalancing strategy with buy-hold.
Here is a side-by-side comparison
of these two most common asset
allocation rebalancing strategies.
(For background reading, see
Asset Allocation Strategies.)

Buy-Hold Rebalancing
The objective of buy-hold is to buy
the initial allocation mix and then
hold it indefinitely, without
rebalancing regardless of
performance. The asset allocation
is allowed to vary significantly from
the starting allocation as risky
assets, such as stocks, increase or
decrease. Buy-hold essentially is a
"do not rebalance" strategy and a
truly passive strategy. The portfolio
becomes more aggressive as
stocks rise and you let the profits
ride, no matter how high the stock
value gets. The portfolio becomes
more defensive as stocks fall and
you let the bond position become a
greater percentage of the account.
At some point, the value of the
stocks could reach zero, leaving
only bonds in the account. (For
background reading, see Finding
Solid Buy-And-Hold Stocks.)

Constant-Mix Investing
The objective of constant-mix is to maintain a ratio of, for example, 60% stocks and 40% bonds,
within a specified range by rebalancing. You are forced to buy securities when their prices are
falling and sell securities when they are rising relative to each other. Constant-mix strategy takes
a contrarian view to maintaining a desired mix of assets, regardless of the amount of wealth you
have. You essentially are buying low and selling high as you sell the best performers to buy the
worst performers. Constant-mix becomes more aggressive as stocks fall and more defensive as
stocks rise. (To read more about contrarian investing, see Buy When There's Blood In The
Streets.)

Returns in Trending Markets

The buy-hold rebalancing strategy outperforms the constant-mix strategy during periods when the
stock market is in a long, trending market such as the 1990s. Buy-hold maintains more upside
because the equity ratio increases as the stock markets increase. Alternately, constant-mix has
less upside because it continues to sell risky assets in an increasing market and less downside
protection because it buys stocks as they fall.

Figure 1 shows the return profiles between the two strategies during a long bull and a long bear
market. Each portfolio began at a market value of 1,000 and an initial allocation of 60% equities
and 40% bonds. From this figure, you can see that buy-hold provided superior upside opportunity
as well as downside protection.

Figure 1: Buy-hold vs. constant-mix rebalancing

Copyright  2009 Investopedia.com

Returns in Oscillating Markets

However, there are very few periods that can be described as long-trending. More often than not,
the markets are described as oscillating. The constant-mix rebalancing strategy outperforms buy-
hold during these up and down moves. Constant-mix rebalances during market volatility, buying
on the dips as well as selling on the rallies.

Figure 2 shows the return characteristics of a constant-mix and buy-hold rebalancing strategy,
each starting with 60% equity and 40% bonds at Point 1. When the stock market drops, we see
both portfolios move to Point 2, at which point our constant-mix portfolio sells bonds and buys
stocks to maintain the correct ratio. Our buy-hold portfolio does nothing. Now, if the stock market
rallies back to initial value, we see that our buy-hold portfolio goes to Point 3, its initial value, but
our constant-mix portfolio now moves higher to Point 4, outperforming buy-hold and surpassing
its initial value. Alternatively, if the stock market falls again, we see that buy-hold moves to Point 5
and outperforms constant-mix at Point 6.
 Figure 2
Copyright  2009 Investopedia.com

Conclusion
Most professionals working with retirement clients follow the constant-mix rebalancing
strategy. Most of the general investing public has no rebalancing strategy or follows buy-hold out
of default rather than a conscious portfolio management strategy. Regardless of the strategy you
use, in difficult economic times, you will often hear the mantra "stick to the plan", which is
preceded by "be sure you have good plan". A clearly defined rebalancing strategy is a critical
component of portfolio management.
METHODOLOGY

1. INVESTOR A

2. INVESTOR B

3. INVESTOR C

INVESTOR A- 100 % EQUITY WITH SOME HDFC EQUITY FUND ON 1ST JAN 08
and he reviews his fund on 31st March 09

INVESTOR B- 100% in gilt fund/BOND FUND of hdfc fund. On 1st Jan 08 and he
rewiews his fund on 31st march 09

INVESTOR C – INVEST 50000 IN EQUITY

INVEST 50000 IN DEBT

And he reviews his portfolio in every three months till 31st march 09

1 lac – 50000 debt

50000 equity

Now, after 3 months 1, 10,000 so he then rebalances 55000 in debt

55000 in equity

So actual capital appreciation is 8000 in debt

And 2000 in equity, so to rebalance he is then giving 3000
in equity so this is how he will rebalance in every three months like he will transfer
sometime from dent to equity and sometime from equity to debt like when the portfolio is
at say 90000 so and we will come to know that this investor is a smart investor and he is
maximizing return but the above two investors are foolish investor they have done their
investment and forgot after that .

So the 3 rd investor is rebalancing

So he is not having the risk of equity like investor A

And , he is not even loosing out of return by rebalancing his portfolio.