What is Financial Asset Allocation?
By Jeffrey S. Coons; Ph.D, CFA
By Christopher J. Cummings; CFA, CFP™
Once the risk management goals and objectives for a physician’s financial portfolio have been identified and prioritized, the next step is to build a mix of investments that will best balance those conflicting goals.
Asset allocation is defined as the portfolio’s mix between different types of investments, such as stocks, bonds, and cash. The goal of any asset allocation should be to provide a level of diversification for the portfolio, while also balancing the goals of growth and preservation of capital required to meet the medical professional’s objectives.
Establishing the appropriate asset allocation for a physician investor’s portfolio is widely considered the most important factor in determining whether or not he/she meets his/her investment objectives. In fact, academic studies have determined that more than 90 percent of a portfolio’s return can be attributed to the asset allocation decision.
So, how do physician investors and their advisors typically make asset allocation decisions?
One method is best characterized as a passive approach, in which a set mix of stocks, bonds and cash is maintained based on their historical risk/return tradeoff. The alternative is an active approach, in which the mix among various asset classes is established based upon the current and expected future market and economic environment.
In addition to pursuing a passive investment strategy, such as indexing, medical professionals supporting the notion that market prices accurately reflect all available information generally are not concerned with the timing of their investment decision.
The most frequently used strategy to avoid a market timing decision when establishing an initial allocation to stocks is referred to as dollar cost averaging. Dollar cost averaging entails investing the same amount of money at regular intervals.
For example, an investor who wishes to dollar cost average may decide to invest 1/24 of the allocation on the first of each month for two years rather than investing the full amount immediately or trying to time buys when stocks are trading at a low point.
Value-cost averaging does the same thing with the same number of shares, rather than dollar amount, for its regular intervals.
Now, what is your personal favorite strategy?