how to create a good Asset Allocation Plan?

[yogi]

Investing is a difficult exercise for most people, and more so for young and new investors who do not have prior experience with handling money and balancing unforeseen risks. The complexity of which investment avenues to choose is further complicated by the huge amount of options available, and the phenomenal amount of marketing done by major investment houses through advertisements, blogs, financial newspapers, magazines, financial advisers, and personal investment websites.

So how should a newcomer invest their hard earned money without subjecting it to unnecessary risk, and to get the worth of their money proportional to the risk that they are taking? Many people end up recruiting a personal financial adviser for this important task. But not all advisers provide advice which is beneficial to the investor, and that is a hard truth. It is difficult to get objective advice from a financial adviser, who as a part-time is also in-charge of selling a financial firm's products, and gets a cut from it.

So there is absolutely nothing equivalent to an investor getting him/herself acquainted with the financial goals, and investment choices available to them, and taking an informed decision.

Step 1 - Create your investment goals and time line

The first step in investing is to create an investment objective, a financial goal, and associating a time line of achieving those goals. Most people have short term (now to three years), mid term (three to ten years), and long term (10 to 30 year) goals. Short term goals can be things like saving for a coming vacation trip around the world, or house repair, or paying off a credit card loan etc. Mid term goals can be saving for a house purchase, saving for a kids coming college/education costs, etc., and long term goals can be money growth, inflation protection, saving for a newborn kid's future education, etc.

Step 2 - Explore the investment options available and measure their risk in accordance with your goals and time line

There are many classes of investment available:

1) Stocks and equities (Domestic and Foreign)
2) Bonds (Domestic/Foreign/Government/Institutional & Corporate)
3) Commodities (including precious metals like gold & silver, and resources like Oil, Copper, Aluminum, Uranium, etc.)
4) Real estate (commercial/residential/agricultural)
5) Currency and Foreign Exchange arbitrage (US Dollar/ Indian Rupees/Euro/Yen, etc.)
6) Special investments, like carbon credits, domain names, production of specific agricultural produce (like lemons, flowers, etc.) that has huge future potential, exotic financial products like CDS, Options trading, and sub-prime mortgages (not kidding!)

We will try to cover each of the above asset class so that investors are informed of the risks and gains involved in each choice, and they can make informed decisions.

Step 3 - Create an Asset Allocation Plan (AAP)

Once you have determined the timelines and investment vehicles, its time to think through how much of your hard earned savings to allocate in to each of the investments, so that you are able to achieve your goals in a timely manner. We will cover this specific area in greater detail, but as a start one should take a look at Step 4 of this interactive article in Fortune, where PIMCO's CEO Mohammed El-Erian tells his ideal AAP. But what's important to understand is that every investor has their own risk tolerance levels, and different financial objectives. So one should not blindly follow any advice.

Below is the AAP proposed by El-Erian (for long term investments only).

[sreddy]

For Savers, It Was Hardly a Lost Decade (NYtimes.com)

This is a very informative article about the importance of having the right mix of assets in one's portfolio, and the importance of rebalancing their AAP.

No one knows which asset class will outperform the others over the next 10 (or 45) years. That’s why it’s important to invest in more than just stocks, and why a bad stretch for certain stocks may not matter as much as it first appears. Few of us have the long-term investing prowess to pick the right moment for the right stocks. But persistence has its own rewards. Savers are never losers, even if some stocks have let us all down in the short term.