Why your asset allocation should be flexible--like basketball
February 28, 2011
Asset allocation is a little like position assignments in basketball: there are distinct roles, but in reality they become somewhat fluid. Like a basketball coach, you should keep your asset allocation flexible enough to adapt to the current situation.
For example, the traditional basketball line-up is two guards, two forwards, and a center player. However, sometimes a team may go with a three-guard line-up, and often teams play without a true center. Similarly, asset allocation should have both general parameters and the ability to adjust to the situation. Certainly, with average rates on savings accounts and money market accounts down around 0.20 percent, an adjustment might seem tempting.
Fixed vs. active asset allocation
Conventional retirement planners will often suggest a fixed asset allocation, based on the historical characteristics of cash, stocks, and bonds. The problem is that investment history doesn't repeat itself in an orderly manner. Anyone who has expected the usual high returns from stocks over the past decade has found that out the hard way.
A better approach is to let history be a guide, but not an absolute dictator of asset allocation. So, a person with two years to retirement should probably not be 100 percent in stocks, and neither should a twenty-five-year-old's retirement account be primarily in cash. However, within certain sensible parameters, they should adjust their allocations to meet prevailing risks and opportunities, and profit.
For example, currently, you may be thinking about switching out of those low-paying savings accounts, money market accounts, or CDs to other securities. Bonds, for example, will give you a bump in yield to above 3 percent, but unlike deposit accounts they will lose money if interest rates rise. Stocks have the potential for higher growth, but having already bounced back by more than 75 percent from their early-2009 lows, they also represent more risk and less return potential than they did a year or two ago.
In short, a basketball coach must always be ready to assess risk and make a substitution. Before doing so though, he must have an idea whether the player going in is any good, so do your research beforehand.