An asset allocation model that is divided into asset categories provides a practical template for analyzing an investment portfolio. To a certain extent, I look at each asset category as a separate portfolio.
I like to keep it simple, so I have chosen just four categories for the Arbor Asset Allocation Model Portfolio (AAAMP): global income, dividend growth, international growth, and aggressive growth. You might choose a different number of asset categories. How many, or what you label your categories, is less important than organizing in a manner that best helps you analyze your portfolio.
There are two benefits to dividing your portfolio into asset categories. First, you can instantly discern the percentage of your portfolio allocated to each category. Secondly, you can quickly determine whether each asset category is properly diversified. Treat each asset category like it’s a separate portfolio.
GLOBAL INCOME 25%
Money Market 15%
DIVIDEND GROWTH 25%
INTERNATIONAL GROWTH / DEEP VALUE 25%
DOMESTIC GROWTH / DEEP VALUE 25%
In this example you can immediately determine that 25% is allocated to each asset category. By listing the individual investments within each category by percentage, from the largest to the smallest allocation, you can analyze the diversification within each asset category.
These are the Asset Allocation Categories I have Chosen:
Preservation of capital should be the most important objective of your portfolio asset allocation. This possibly makes Global Income your most important asset category. This is because cash is within the global income category and should be used to protect the portfolio from large portfolio drawdowns.
The dividend growth category should contain the more stable stocks that provide dividend income and the opportunity for dividend growth compounding. Ideally you want to own companies that are able to grow the dividend over time. This provides for double compounding because the dividend compounds when you buy more shares with each dividend, and the dividend paid on each share also grows.
International Growth / Deep Value
Not all investments move together. Even though correlations between stocks in different markets have become higher is recent years, there are still diversification advantages to global investing. In addition, it is a huge advantage to expand the universe of available investments; particularly for the value investor. More choices mean higher probabilities of finding undervalued assets.
Domestic Growth / Deep Value
This is the category I place investments that do not fit into the above categories. This would include domestic stocks that pay little or no dividends, domestic small or micro cap stocks, industry specific ETFs, and portfolio hedges such as inverse ETFs.
Your Asset Allocation Model
Your asset allocation model portfolio might be different. The point is to have a model that allows you to analyze your asset allocation and evaluate for proper investment diversification within each asset category.
If you are just “winging it” you might not have a clear understanding of your portfolio asset allocation. Is it balanced? Is it properly diversified? Investors should have an asset allocation model that provides clarity as to where their money is allocated and whether it is properly diversified.
Related Reading: 7 Investment Concepts Fundamental to Value Portfolio Management