Combining Different Investing Strategies

Posted On: 2007-02-05Length: 9:46

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Is there any such state as investing nirvana? If there is, how can you get there? We'll try to find out in this Fidelity Personal Finance podcast.

There are literally hundreds of factors that can influence the success or failure of an investing strategy. Investment analysts regularly examine different combinations of these factors over different periods, and under different market conditions to see which portfolio approaches have had the most favorable outcomes over time. Van Harlow, president and chief investment officer of Strategic Advisors, Incorporated, a subsidiary of FMR Corporation says, the concepts of asset allocation and diversification surface again and again, as we explore how investments and markets react over time. Now these terms are often used interchangeably. The fact is, there's a small but significant difference, according to Van Harlow and other experts. Asset allocation is more of a process. Diversification is the result. A diversified state is where you want to end up, and that's an investor's nirvana, according to Van Harlow. Although neither ensures a profit or guarantees against loss, these concepts should shape everyone's investment plans and choices. This is especially true as you approach and reach retirement. As you look to ensure that your assets last throughout your lifetime, asset allocation may be the single largest contributor to your portfolio's return. Furthermore, efficient diversification may be the best way to lower your portfolio's risk while seeking to maintain its expected return.

Just what do we mean by asset allocation? Achieving any long-term financial goals, such as outpacing inflation and retirement, can be influenced greatly by how you distribute your savings. This is what's meant by allocating your assets among stocks, bonds, and short-term investments, the three major asset classes. Numerous analyses have shown that strategic asset allocation is the most determinant of a portfolio's returns. Consider a landmark study of 82 diversified pension funds done in 1986. It's called, Determinants of Portfolio Performance, by Gary Brinson, Randolph Hood and Gilbert B. Bauer, and it concluded that basic asset allocation choice accounted for fully 91.5% of the variance in returns among different pension funds. Only 8.5% of the difference in returns could be attributed to the selection of specific securities, or the timing of when the investments were bought and sold. But there's another reason that smart investors sing the praises of asset allocation. Van Harlow explains that, strategically hedging your bets can help to mitigate risks and smooth the impact of volatility, and by doing so, boost return opportunity throughout a range of market environments. The important thing is, asset allocation helps you maintain your balance. The three major asset classes have widely divergent performance characteristics. Historically, stocks have dramatically out-performed bonds and short-term debt, over lengthy periods of time. Although...