Asset Allocation Application in Unit Trust Investment

Follow up to my previous post commenting about Public Mutual’s Far-East Select Fund and China Select Fund, Lim would like to know more about the right mix of high risk and low risk investment. In other words, Lim is actually interested to learn about the asset allocation in unit trust investment.

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and liquid cash. The right mix for a person is actually very personal. The reasons that almost every investor possesses a different investment portfolio are:

1. Time Horizon

This is the time frame when you expect to achieve your financial goal. The most common reference is:

• Short term – from a few weeks to a year
• Medium term – from 1-5 years
• Long term – more than 5 years.

The longer the term, the higher the risk you can take. Because you will have the comfort of waiting out slow economic cycles and make the gain at economic boom. Vice versa, less risk is allowable for short period of investment.

Example:
Investor age 25, investing for retirement at age 55.
Financial goal – save a lump sum of money to provide steady income during retirement.
Due to the remaining years of three decades long, the investor shall be comfortable to bear higher risk in his investment portfolio.

2. Risk Tolerance

Risk tolerance is your ability to accept lose of your original sum invested in exchange for potentially higher return. There are generally two kinds of investor:

• aggressive investor – high risk tolerance, got a great risk appetite. Younger males are normally more aggressive.
• conservative investor – prefer investment that will preserve her wealth. Normally older females are more conservative.

You can actually scale yourself by doing risk profile assessment from 1-10. Score 1 for conservative investor and 10 for the most aggressive. Most people will be anywhere in between. In the words of the famous saying, conservative investors keep a “bird in the hand,” while aggressive investors seek “two in the bush.”

Asset Allocation Guide

1. Determine your financial goal with the proper term
An example of a well defined goal is something like this:

I want to have $1 million liquid retirement fund when I reach age 55, by putting in the lump sum of $50,000 I have now and saving regularly 10% of my nett income.

The more specific the better it is. The most important thing is to determine your investment term – how many years?

2. Assess your risk tolerance
Here are a list of forms which can guide you to assess your risk and give some recommendation.

• Risk Analysis at NetInvestmentAdvisor.com
  
• 10 questions, one clear answer from Citibank
• Risk Profile Assessor from Sentry Insurance

3. Lower the risk by choosing the appropriate asset classes with the best correlation relationship.
From wikipedia,

A more fundamental justification for asset allocation is the notion
that different asset classes offer non-correlated returns, hence
diversification reduces the overall risk in terms of the variability of
returns for a given level of expected return. In this respect
diversification has been described as “the only free lunch you will
find in the investment game.”

Let’s look at it this way: Stock and bond are negatively correlated. When stocks go down, bond tends to perform better. So it is a very common strategy to allocate your fund in both stocks and bonds so that the risk is somehow canceled off on each other.
In short, the best portfolio can produce the targeted return at the lowest risk.

I will write another post in the future explaining about correlation. Please bear in mind that I am not a CFA (Certified Financial Analyst) and I don’t intend to become one in the near future. However, I can assure you that I always research before publishing my articles. Please bear with my shallow knowledge and let’s learn together!

4. Use the help of asset allocators
Here is a list of asset allocators which take into account your personal preference to suggest a portfolio. This is the easiest way and the fastest way to get an analyzed recommendation.

SmartMoney.com Asset Allocator

CNNMoney Asset Allocator

Asset Allocator

Related article about unit trust:
Bottom Up Approach in Unit Trust Investment Malaysia
Top-Down Approach in Unit Trust Investment
The secret of investing in Unit Trust

So how do you determine your investment portfolio? What’s your rules of thumb?

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