The Ins and Outs of Asset Allocation

By Michelle Singletary
Sunday, July 5, 2009

I met a woman who asked me to review her 401(k) portfolio. She was worried about how she had allocated her contributions.

I wasn't going to tell her where to put her money. She said she just wanted my opinion on whether she was diversified enough. Her employer's plan had about 15 investment choices, from conservative to aggressive.

This woman, bless her heart, was investing her contributions, which probably didn't total more than $100 a month, in all the choices. To make matters worse, she was clueless about the various asset classes into which she was dicing her money. She had simply heard that she should diversify.

This woman, along with many other novice investors -- and that really includes most of us -- could have used "Asset Allocation for Dummies" (Wiley, $24.99), which is my pick for the Color of Money Book Club for July.

First, let me say I'm not a fan of the word "dummies" in the branded series of books published by Wiley. I think it's a little off-putting. Yet I appreciate the intent of the series: Various authors try to explain, in the simplest terms, subjects that can be intimidating to a lot of people.

For so many, asset allocation is something they know they should do, but don't do, because it can be intimidating. But Jerry A. Miccolis, a certified financial planner and co-owner of Brinton Eaton Wealth Advisors in Madison, N.J., and his co-author, Dorianne R. Perrucci, a financial journalist, have done their best to simplify this investment strategy.

"We think it is crucially important right now, given the turmoil in the economy and in the financial markets, that people get back to basics in their investing," Perrucci said when I asked her why this book is important.

So, what exactly is asset allocation?

It's "deciding how to divvy up your investment dollars among various types of assets," Miccolis and Perrucci point out.

Like the woman I described, some investors take asset allocation too far.

"Simply choosing one of everything from your employer's 401(k) investment menu can be dangerous," Miccolis said. "It's akin to making a cake by throwing in everything you happen to see in the pantry. This would likely make for a pretty unappetizing cake."

Or people ignore asset allocation completely, putting all or most of their money in one stock or one asset class.

I will never forget the stories of Enron employees and retirees who put the bulk of their retirement accounts into the company stock. When the energy firm went bankrupt, their wealth evaporated.

These Enron employees and retirees violated one of the immutable laws of sound investing, Miccolis and Perrucci write: "Never, ever put too many of your eggs in one basket."

Getting the right asset mix can account for more than 90 percent of investment results, the authors report.

In 321 pages, not including the index, Miccolis and Perrucci walk readers through the ins and outs of asset allocation in bite-size, digestible chapters. The paperback book is separated into five sections covering, among other things, the basics of asset allocation and how to fill your investment basket with specific asset classes. You'll learn about weighing risk and return, why you need to rebalance your portfolio, alternative investments such as commodities and real estate, and how taxes affect your choices. The authors list the most important asset classes and their historical rates of return. Don't skip the part on 10 common asset-allocation mistakes.

I know a lot of people have pulled back from investing. I understand why. The stock market has been so frightful and the losses so great. Some investors have even declared that asset allocation failed them in the recent market downturn.

"Asset allocation was never designed or intended to avoid loss in all conceivable, let alone inconceivable, situations," Miccolis says. "It is designed to get you the best result given your risk tolerance. Virtually everything you could invest in -- save some categories of Treasury bonds -- lost considerable value at the same time. The nature and extent of that massive combined downturn was in many ways unprecedented."

With apologies to Winston Churchill, Miccolis admits that asset allocation is a flawed system but adds that "it's just worlds better than whatever is in second place."

It's easy to be a member of our book club. We don't meet -- in person, that is. We do come together for a live online discussion. Join me at noon July 30 at http://www.washingtonpost.com/discussions. Miccolis and Perrucci will be available to take your questions about asset allocation.

Every month, as a bonus, I randomly select readers to receive a copy of the selected book, donated by the publisher. For a chance to win a copy of "Asset Allocation for Dummies" send an e-mail to colorofmoney@washpost.com. Please include your name and address.

-- By mail: Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

-- By e-mail: singletarym@washpost.com.

Comments and questions are welcome, but because of the volume of mail, personal responses are not always possible. Please note that comments or questions may be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.

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