Asset Allocation

by James Lindsay

Assets, financially-speaking, are the things in your portfolio that are worth something because they make you richer, either because they grow in value or because they pay you an income. They’re different from liabilities because liabilities make you poorer. So the first thing about asset allocation is to make sure that you allocate your wealth to places where it won’t become a liability.

There are two things to remember here: timeframe and diversification. Yes, I’m sorry to those of you who would like hot stock tips and exciting technical reasons why managed futures and credit default swaps will outperform big blue chips, but this is going to be a sensible reminder of the basics.

So, two questions when allocating your money: first, how long am I going to put it away for? And, second, do I already have too much of this type of investment? If you’re looking at a timeframe of over 10 years, and you’re looking to maximise your returns, then you can look at more volatile investments, which, in the main, means the stock market. Why do stocks do well over the long-term? Because companies make money. There’s no magic to this. Those profits are returned to the shareholders as dividends, which form a significant chunk of your investment return, and the profits mean that the value of the stock rises because other investors will want to buy your stock so they can benefit too. So buying into big companies in established and/or emerging markets over a time period of over 10 years is likely to give you a chance to get better returns than keeping your money in the bank. None of the turbulence since 2008 has changed any of that.

What about under 10 years? Whatever you’re saving for, whether it’s a wedding, a yacht, or retirement, if you want the money within 10 years, then you’re risking losing money by being in the stock market. Perhaps over the next 5 to 10 years the world’s stock markets will, on average, outperform cash. But it’s far less certain when we’re talking about the medium-term rather than decades. Property, too, at this timeframe, is risky; property slumps can easily take over five years to hit bottom. So short- to medium-term, with money you can’t afford to lose, look for the best cash-deposit rates and vary the currency.

Which brings us to the second point: diversification. Living overseas, we get a better range of options for our investments. Thinking specifically about cash, we get to hold RMB. This is a Good Thing. I’m not saying that the yuan is definitely going to grow in value over the short- or medium-term. I’m saying it’s a good thing to be able to diversify away from just my home currency so easily. So hold some of your short- or medium-term savings in RMB and some in your home currency. I’d also get a multicurrency bank account in Hong Kong and keep some savings in a third major currency too (US dollars, Japanese yen, Swiss francs). People who think they know about this kind of thing will say, “Oh, the Japanese yen is overvalued right now, I’ve got a few thousand Rwandan francs in my basket. I’m sure it’s about to take off”. But they’re missing the point. I’m not speculating on the right now. I’m just keeping my cash safe, over the short- to medium-term.

Same goes for stocks. If you’re interested in technology, don’t just buy Apple. Buy Apple, Google, Microsoft and IBM. And don’t just buy tech in the US, or your home market, buy stocks from all over the world. Add Baidu to that list. Of course, the best way to diversify when you’re buying stocks is to use funds, where the big pool of money means the fund manager can buy into dozens or hundreds of stocks at one time. But if you’re buying funds, remember to compare costs. Indexes will save you a lot of money and won’t underperform over the long-term, on average.

And that’s what asset allocation, and timeframe and diversification, are all about. Average. But it’s about getting a better average. It’s about safely beating what you’ll get in your current account by getting a higher average through different types of investment. It’s less exciting, but you’ll be pleased in the long-run.

James is the editor of ‘eg’, the online money magazine for expats in Shanghai. Visit www.egmoneymagazine.com to read more about making the most out of your money.