Who: This post is for people who are looking to create an investment plan for themselves. It may help if you have read the first part in the series, Investing 101: Components to Create an Allocation.
What: This is the second post in the series of the basics on investing. This post will briefly discuss asset allocation and what it means for different people.

[ Investing 101 | Investing 103 | Investing 104 | Investing 105 ]

So, now that we have gone through all of the components of creating an allocation, we can actually go about creating the allocation. If you actually have no idea what I am talking about, you should mosey on down to Investing 101: Components to Create an Allocation.

Now, there are obviously an infinite number of possibilities for allocations based on the variables discussed earlier (Time Horizon, Goals, Risk Profile, Tax Consequences). Throughout the rest of this investment basics series we’ll carry through some sample allocations for 3 of my best friends. Today we’ll start exploring allocations for Spike, Pat, and Jebediah. Let’s check out their Bio’s

Spike
Age: 22
Time Horizon: I got all the time in the world to strike it rich.
Goals: I wanna be rich, really rich.
Risk Profile: Risk? Whatever. Gimme lots of Money. I skydive without a parachute, ford the river with my oxen, regardless of how deep it is, and in blackjack I double down on 12 when the dealer is showing 6.
Tax Consequences: Taxes schmaxes.

Pat
Age: 27
Time Horizon: I’ve got a fair amount of time to invest before I will need to draw out any money. I’d like to take some out in 3-5 years and the rest out in 15-25 years.
Goals: I’d like to buy a house in a couple of years, but I’m looking to have a fair amount of money saved up for my 40’s and 50’s before I can draw from my retirement accounts.
Risk Profile: I like taking calculated risks and am willing to be aggressive. I am not reckless though, I prefer to double down on 11.
Tax Consequences: I make a fair amount of money, so I don’t want tax inefficient vehicles, but I am not overly concerned with tax efficiency.

Jeb
Age: 55
Time Horizon: I am coming up on retirement pretty soon and I will be needing some of my money soon and I will be drawing from my investments throughout the course of my retirement.
Goals: I’d like to live comfortably in retirement.
Risk Profile: I’m too old to be taking too many risks. Just get me marginal return and make sure I don’t lose a lot of money.
Tax Consequences: My income is limited, so let’s make sure that I am not being eaten alive by taxes. I want to pay somewhat close attention to this.

I hope it seems obvious what I am trying to accomplish with my 3 very diverse friends. Each of them has different investment needs. As such, we’ll need to create a very different allocation for each of them. Before I continue, I gotta do it:

Disclaimer: Information provided in this post and on this site is provided without any warranty of any kind explicit, or implied. Investment strategies are opinions of William Wallets and only William Wallets. William Wallets really has no qualifications that make him an investment advisor so everyone relying on information provided here-in is advised to speak to an investment professional after so that they may get information tailored for specific situations.

First, we’ll discuss the concept of asset classes. An asset class is a category of investment that generally exhibits similar characteristics, acts similarly, and is subject to more or less the same rules and regulations. Some examples of asset classes are stocks, bonds, cash, and natural resources. Some asset classes are more volatile than others. In general, the riskier the asset, the higher the return [Investing 101, The Basics III].

For the purpose of simplicity, we’ll split our assets up into 3 groups (least to most risky): Cash, Bonds, and Stocks. Within the cash asset class, we’ll include Certificates of Deposit and Money Market Accounts. Within the bond asset class we’ll include treasuries, investment grade commercial bonds, and high yield bonds. Finally, within the stocks asset class we’ll include large stocks, small stocks, international stocks, and emerging market stocks. By no means is this hierarchy exhaustive or even standard. The purpose of this hierarchy is to create an extremely simple spectrum of risk for asset classes. The nifty graphic below should clarify (I think).

Risk classifications of selected asset classes

The basic premise of creating an allocation is that the sooner you need the money, the more conservative the investments should be [Investing 101, The Basics III]. With this in mind, we’ll create a sample allocation for our 3 friends.


Spike's Asset Allocation

Our buddy Spike has his allocation. As you can see, we have selected to have 85% of his portfolio be in stocks, 10% in bonds, and 5% in cash-like accounts. This allocation is aggressive, which matches Spike’s investment profile. Spike has plenty of time to make his fortune, so he can handle the volatility of stocks. The entire allocation could be stocks, but for the purposes of diversification, some of it is kept in bonds and cash.


Pat's Asset Allocation

Pat’s allocation, shown above is still somewhat aggressive since he is young and has time to grow his nest egg. There is a large portion of his allocation in bonds as well. Why? Well, if we look at Pat’s profile, we notice that he is saving to purchase a house. In other words, there is a fair amount of cash that Pat will want to use in the short term. Since that short term cash cannot necessarily withstand the short term volatility of stocks, we have decided to place that portion of his investments in bonds and cash.


Jeb's Asset Allocation

Finally, we have Jeb, who is moving towards retirement. He will be drawing funds from the account soon, so he does not want to deal with the volatility of stocks. However, he will (hopefully) live for a long time to come. For the long term cash, we have stocks for growth and the short term necessity for preservation of principal is taken care of by investments in stocks and bonds.

I want to make sure that I note that these allocations aren’t “right” or “wrong.” Instead, they reflect an opinion of how to meet certain goals (based on Spike, Pat, and Jeb’s investment profiles). Stay tuned for part III of the series. In part III, we will discuss specific methods for investing in the above allocations. The specific methods will allow you to make determinations on which broker to choose (part V!)

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