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Asset Allocation Models

Different Strategies for all Stages of Life


Model 4 – Growth
The growth asset allocation model is designed for those that are just beginning their careers and are interested in building long-term wealth. The assets are not required to generate current income because the owner is actively employed, living off his or her salary for required expenses. Unlike an income portfolio, the investor is likely to increase his or her position each year by depositing additional funds. In bull markets, growth portfolios tend to significantly outperform their counterparts; in bear markets, they are the hardest hit. For the most part, up to one hundred percent of a growth modeled portfolio can be invested in common stocks, a substantial portion of which may not pay dividends and are relatively young. Portfolio managers often like to include an international equity component to expose the investor to economies other than the United States.


Changing with the Times

An investor that is actively engaged in an asset allocation strategy will find that his or her needs change as they move through the various stages of life. For that reason, some professional money managers recommend switching over a portion of your assets to a different model several years prior to major life changes. An investor that is ten years away from retirement, for example, would find himself moving 10% of his holding into an income-oriented allocation model each year. By the time he retires, the entire portfolio will reflect his new objectives.


The Rebalancing Controversy

One of the most popular practices on Wall Street is “rebalancing” a portfolio. Many times, this results because one particular asset class or investment has advanced substantially, coming to represent a significant portion of the investor’s wealth. In an effort to bring the portfolio back into balance with the original prescribed model, the portfolio manager will sell off a portion of the appreciated asset and reinvest the proceeds. Famed mutual fund manager Peter Lynch calls this practice, “cutting the flowers and watering the weeds.”

What is the average investor to do? On one hand, we have the advice given by one of the managing directors of Tweedy Browne to a client that held $30 million in Berkshire Hathaway stock many years ago. When asked if she should sell, his response was (paraphrased), “has there been a change in fundamentals that makes you believe the investment is less attractive?” She said no and kept the stock. Today, her position is worth several hundred millions of dollars. On the other hand, we have cases such as Worldcom and Enron where investors lost everything.

Perhaps the best advice is to only hold the position if you are capable of evaluating the business operationally, are convinced that the fundamentals are still attractive, believe the company has a significant competitive advantage, and you are comfortable with the increased dependence upon the performance of a single investment. If you are unable or unwilling to commit to the criteria, you may be better served by rebalancing.


Asset Allocation Alone Isn’t Enough

Many investors believe that by merely diversifying one’s assets to the prescribed allocation model is going to alleviate the need to exercise discretion in choosing individual issues. This is a dangerous fallacy. Investors that are not capable of evaluating a business quantitatively or qualitatively must make it absolutely clear to their portfolio manager that they are interested only in defensively selected investments, regardless of age or wealth level (for more information about the specific tests that should be applied to each potential security, read Seven Tests of Defensive Stock Selection.) If the investor’s money is being managed by a professional team with a good track record of identifying excellent businesses at reasonable or attractive prices, small breaches of the tests may be overlooked if the management team can explain, in a few sentences or less, why they believe the position offers both safety of principle and the promise of above-average returns.

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