A step-by-step guide to asset allocation

Your overall asset allocation needs to reflect your future capital or income needs, the timescales before those capital sums are required, or the level of income sought, and the amount of risk you can tolerate.

No two investors’ allocations will be the same but, as a general rule, the more assets you can add to a portfolio using low-cost funds, the lower the volatility and the smoother the returns.

We have shown some typical asset allocations for different objectives, below, and examples of the fund holdings used to achieve them – for illustration purposes only.
1. Set your
financial planning objectives

Financial planning objectives can include providing additional pension income (see also Part One of this series at www.ft.com/diyfinancialplanning), paying for children’s education or property deposits, or meeting care fees – so you may need to use different asset allocations at different times, to match these liabilities.

For example, building up a lump sum over 20 years will require a higher allocation to long-term growth investments, such as equities. However, providing income will require equities, high-yield bonds and gilts.

“It’s all about asking: what is your objective,” says Matthew Merritt, head of investments strategy unit at Insight Investment. “Is it achieving a certain return, or matching a liability stream? Liability-driven investment is the same for an institution as it is for a private investor getting a kid through college.”
2. Set your strategic allocation

A strategic asset allocation is simply the mix of assets to be held in a portfolio for the term of the investment – to achieve a target level of risk and return.

For example, a simple strategic allocation for a 20- year term might be 50 per cent equities, 25 per cent bonds, 15 per cent cash and 5 per cent in both commodities and hedge funds. But, depending on how actively you want to manage your portfolio, you can also use tactical asset allocations in the short term, to exploit temporary economic or market conditions and boost returns. For example, a 5 per cent allocation to commodities may be increased in times of constrained supply – but revert to the normal strategic level once short-term profits are achieved.
3. Add assets to build up your portfolio

If you already hold shares and equity funds, you can simply buy exposure to the other assets needed to achieve your target allocation, and geographical spread. By adding assets with low correlations to your existing holdings – such as bond funds and exchange traded commodities – you will reduce overall portfolio volatility and generate smoother returns.

This can be done at low cost through a discount broker service, for a flat fee of £10-12 per share or fund added, with no initial or administration charge on the funds.

Over the long term, adding assets can enhance returns. For example, a diversified portfolio returning a steady 5 per cent a year will outperform a less well diversified portfolio returning 3 per cent one year and 7 per cent the next – even though the average annual return is the same.

“Open yourself up to broadest opportunity set that you can,” advises Merritt. “It’s not just about equity, government bonds, and property. Consider absolute return-style vehicles that have a different risk/return trade-off, commodities, and other opportunistic investments. Think about diversification not just in terms of asset class and geography but also in the way you manage money. Give money to different fund managers – some active, some passive.”
4. Monitor your asset allocation regularly

An asset allocation may need to be changed over time, for two reasons: rises in the value of assets can increase the volatility of a portfolio, and age can reduce the risk tolerance of an investor – especially in the years before retirement.

To ensure higher-risk assets do not dominate a portfolio, make sure you rebalance your portfolio annually, or when any one asset rises in value by, say, 20 per cent.

Vanguard, the fund manager, has found that, over the long term, a portfolio split 60:40 between equities and bonds but never rebalanced would have gradually drifted towards a more volatile split of 90:10 – because shares historically outperformed bonds.
5. Rebalance your portfolio

Rebalancing simply involves selling some assets that have risen in value and reinvesting the proceeds into those assets that have fallen below their target allocation.

For example, a portfolio that starts with £10,000 in equities and £10,000 in bonds may end the year with the equities up 10 per cent and the bonds unchanged – a 5 per cent return overall. So, to rebalance, you sell £500 of equities and buy £500 of bonds. After paying dealing charges of £10 on the two transactions, the portfolio is still split 50:50: £10,490 in equities, £10,490 in bonds.
6. Consider ‘lifestyling’

To ensure market volatility does not reduce your portfolio’s value just before the money is needed – for example, to provide a lump sum – you should consider gradually moving out of higher-risk assets, such as equities, and into lower-risk assets, such as cash and government bonds, before the money is needed.

This process, known as lifestyling, aims to reduce the volatility in a portfolio over a period of time.

For example, investors in their 30s can afford to hold more equities as they can ride out price fluctuations over time – but investors in their 50s cannot afford as much equity exposure as they have less time to recover from sharp falls.

Lifestyling can be carried out manually, by selling risky assets and holding the proceeds as cash or in government bonds (see “Rebalancing” above). Or you can use target date or “lifecycle” funds, which automatically change their asset allocations to accumulate capital gains in the early years and then protect them to deliver a lump sum, or generate income, on a specified target date.

Target-date funds are now offered by fund managers Vanguard and Fidelity, and allow investors to choose a fund with a target date nearest to when they will need to drawdown capital or income.

For example, a 30-year-old planning to retire in 35 years’ time might choose a 2045 fund. However, regulators in the US have expressed concern about the wide variation in performance between funds with the same target date.

Wife wins in court's property shock

A landmark Supreme Court judgment has opened the way for wives to take a share of their husbands' property - even though they owned it before the marriage.

A prominent Auckland family law barrister has described the decision as "shocking", saying the woman has won a huge payout as a result of her performance of domestic chores during the 24-year marriage.

The court says the woman is entitled to almost half of the increased value of the couple's farm, even though her ex-husband inherited it before their marriage.

The long-running dispute case - heard before four different courts - is expected to open the floodgates on a series of similar disputes.

The Supreme Court has agreed with the Court of Appeal the woman is entitled to a 40 per cent share of the increased value of her husband's farm, even though he owned it before their marriage in 1979. They separated in 2003.

The woman argued that as the homemaker, her duties helped her husband focus on developing the farm and, later, a vineyard on the land.

At stake were two properties - the second was inherited by the husband in 1995, during the marriage.

The wife won at Family Court level, but lost in the High Court. For round three, the Court of Appeal said the wife was entitled to almost $560,000 for both properties. Both parties appealed to the Supreme Court - the husband said his wife was not entitled to any of that money; she said she was entitled to more.

"The argument for the wife was that her actions since marriage had freed up the husband to undertake work solely for the benefit of his separate property and that she had prevented the debt from reaching an unsustainable level," the Supreme Court said.

"In addition to looking after the children and managing the household, she had earned over $300,000 from outside employment, all of which she had contributed to the household."

The wife asserted had it not been for her actions the farm would have been sold to ease debt, and neither party would have seen the "spectacular increase" in the value of the property.

Barrister Anthony Grant has described the case as involving "the annihilation by stealth of separate property". He says the case is "shocking" and "a stunner", not necessarily because it was wrongly decided, but because people had not been aware that "indirect contributions" involving something as ordinary as household chores could convert a spouse's separate property into relationship property.

"In a typical marriage where, say, the husband has separate property from an inheritance or a prior relationship he is now liable to lose it if his wife can say that her doing the housework helped him to increase the value of the property. While he was at his desk working on his separate property affairs and his wife was doing the dishes, sweeping the floor, feeding the kids, and so on - she was simultaneously taking the separate property!"

SEC blamed for failing to spot Madoff fraud

Harvey Pitt, the former head of the US Securities and Exchange Commission, on Thursday delivered a measured, but trenchant indictment of his former employer over its “terrible failure” to spot the Ponzi fraud of Bernard Madoff, who on Monday was sentenced to 150 years in jail.

Mr Pitt, who was SEC chairman for 15 months between 2001 and 2002, confirmed that the regulator had been given evidence of alleged wrongdoing by Mr Madoff’s business at various points – in 1992, 1999, 2005 and 2006. “But during [my tenure], there was no indication whatsoever that Madoff was doing something wrong,” he said.

Staff at the regulator, he said, had always “lacked the sophistication and skillset” necessary to do their jobs effectively. The SEC was staffed with too many lawyers and not enough economists and market practioners, said Mr Pitt, himself a former lawyer.

Commenting on the SEC’s future, Mr Pitt said he admired the calibre of US president Barack Obama’s team and was broadly supportive of its desire to reform the regulatory environment. But he said political expediency meant grand plans for new structures – for example to speadhead consumer protection – would crash into existing bodies. “Rather than eliminating the SEC now, there is an effort to make it even less relevant than some think it’s already become,” Mr Pitt said. The result was an “emasculated” SEC.

Mr Pitt resigned from the SEC in November 2002, after a difficult period during which Enron and Worldcom both collapsed. He was seen by critics as having been slow to address the problems of biased equity research on Wall Street.

Speaking on Thursday at the offices of CQS, a London-based hedge fund on whose advisory board he sits, Mr Pitt also laid out his blueprint for the direction he thought regulatory reform should take.

Having spent recent months advising governments on both sides of the Atlantic, in his capacity as chief executive of regulatory consultancy Kalorama Partners, he said current ideas for “extensive and, I believe, invasive regulation” seemed to be directed at “fighting yesterday’s crisis”. “The next crisis, we can be pretty sure, won’t look anything like the last one,” he said.

The answer, Mr Pitt said in a familiar refrain, was to adopt the more principles-based approach that the UK’s Financial Services Authority has traditionally used. “The FSA model is a good model and one that the US would do well to follow,” he said, though the FSA has recently redefined itself, under chairman Lord Turner, as an “outcomes-based” regulator and has moved away from its former “light-touch” style.

Mr Pitt said there were two key principles vital to ensure effective financial regulation. The first was a need for more data to be disclosed by banks and hedge funds to government, though that information should only come back to the markets in aggregate form. In particular, hedge funds should be obliged to disclose potential conflicts of interest, for example if they were simultaneously invested in a company’s equity and debt.

The second was a need for government to have a “residual regulatory authority”, allowing it emergency powers to intervene in the financial system if it saw that by certain measures, such as leverage, the economy was overheating.

Blue Chip founder hit with $11m debt

Blue Chip co-founder Mark Bryers has racked up another debt - this time $11.2 million to Westpac.

The High Court last week awarded summary judgment to Westpac NZ Ltd against Bryers after he guaranteed a company debt.

The judgment, which opens the door for bankruptcy proceedings, is among several already awarded against Bryers, including one for $4m.

So far the head of the failed Blue Chip group has eluded bankruptcy and continues to run a property investment business in Australia.

Citing client confidentiality, Westpac declined to specify the name of the company, the full amount of the debt or whether the bank planned to proceed with bankruptcy proceedings.

Bryers' business partner, Bob Bangerter, was bankrupted in April by Wellington property magnate Bob Jones' company after $398,000 in rent was left unpaid in an Auckland tower block following the Blue Chip collapse.

After a group of Blue Chip-related companies went into liquidation in February last year, thousands of investors were left a combined $80m out of pocket.

Bryers, 51, also faces more than 100 criminal charges brought by the Companies Office and seven charges relating to a lodge he managed on the Whangaparaoa Peninsula.

Folic acid law shock for Hide

MP Rodney Hide warned New Zealand Food Safety Minister Kate Wilkinson against mass medicating bread with folic acid three months ago - a month before the Herald on Sunday broke the story.

Hide, as Minister of Regulatory Reform, said he was "shocked" to learn breadmakers were being forced to add folic acid to all bread and urged Wilkinson - who does not eat bread - to delay the decision. In his April 16 letter, Hide expressed concerns about the lack of choice and potential health risks linked to folic acid.

Ireland and the United Kingdom had recently postponed their plans to force breadmakers to add folic acid because of concerns about links with cancer, he wrote.

"Choice is something that is very important to my party and I had thought to yours ... I don't think the New Zealand public will be happy to find out that there are plans to mass-medicate 4.3 million of them through a product they have no choice but to consume."

Wilkinson, who does not eat bread because she is gluten intolerant, said in a statement she was aware of Rodney Hide's concerns.

"The Prime Minister has sought further advice and we are working to find a suitable solution."

Last week Hide said New Zealand had rejected "the nanny state" in the last election.

"It seems to me the only argument in favour of it is we might upset the Australians which I thought was a plus."

Suicide blasts at Jakarta Ritz, J.W. Marriott kill 9

JAKARTA, Indonesia -- Suicide bombers who checked in as guests smuggled explosives into American luxury hotels in Indonesia's capital and set off a pair of heavy blasts that killed nine people and wounded more than 50, investigators said Friday.

The near-simultaneous bombings ended a four-year lull in terror attacks in the world's most populous Muslim nation. At least 18 foreigners were among the dead and wounded. The blasts at the J.W. Marriott and Ritz-Carlton hotels, located side-by-side in an upscale business district in Jakarta, blew out windows and scattered debris and glass across the street, kicking up a thick plume of smoke. Facades of both hotels were reduced to twisted metal. An Associated Press reporter at the scene saw bodies being shuttled away in police trucks.

Alex Asmasubrata, who was jogging nearby, said he walked into the Marriott before emergency services arrived and

“there were bodies on the ground, one of them had no stomach,” he said. “It was terrible.” Two Australians and a New Zealander were believed to have been killed, but there was confusion about the exact number of victims.

“I have grave concerns for three Australians following the terrorist bombings in Jakarta earlier today,” Australian Prime Minister Kevin Rudd told reporters late Friday. “One of these Australians is an Australian Embassy official. These figures may be the subject of further change.”

An Australian think tank, the Strategic Policy Institute, predicted the Southeast Asian terrorist group Jemaah Islamiyah might launch new attacks just a day before Friday's deadly strike.

A paper released Thursday said tensions in the group's leadership and the release of former members from prison “raise the possibility that splinter factions might now seek to re-energize the movement through violent attacks.”

Indonesian President Susilo Bambang Yudhoyono said the attack was carried out by a “terrorist group” and vowed to arrest the perpetrators. He also suggested a possible link to the national election last week that is expected to hand him another five-year term as president, but he provided no details. Suspicion will fall on the Southeast Asian Islamist militant group Jemaah Islamiyah or its allies. The network is blamed for past attacks in Indonesia, including a 2003 bombing at the Marriott when 12 people died.

“Those who carried out this attack and those who planned it will be arrested and tried according to the law,” a somber-looking Yudhoyono told a news conference.

The Manchester United football team canceled a planned visit to Indonesia. The team had been scheduled to stay at the Ritz on Saturday and Sunday nights for a friendly match against the Indonesian All Stars, the Indonesian Football Association said.

Iran, Russia to Hold Joint Naval Exercise

LONDON, July 19 (IranMania) - Iran and Russia are scheduled to hold a joint maritime exercise in the Caspian Sea on July 28-29, an Iranian official said on Sunday Fars News Agency reported.

Managing Director of Iran's Ports and Shipping Organization Taheri Motlaq said that the maneuver, due to be held in the northern Iranian port city of Bandar-e-Anzali, is aimed at enhancing the safety of transportation in the Caspian Sea.

Taheri Motlaq was quoted by the Islamic republic news agency as saying that the exercise will be held within the framework of international conventions such as those on the prevention of sea pollution.

According to the official, the exercise will be dubbed as "Regional Interaction, Key to Safe and Clean Caspian Sea".

"Over 30 modern vessels and two helicopters will take part in the exercise," he added.