In an ideal world my investment asset allocation would be done in the following manner:
1. Determine what initial amount to invest and ongoing savings plan
2. Determine my risk tolerance and any constraints regarding what investment types I choose to invest in (eg. ethical funds, hedge funds etc)
3. Decide my timeframe and investment targets (eg. final amount for retirement, target ROI or whatever)
4. Select an appropriate asset allocation to meet my investment return target with minimal risk (ie. aim for the efficient frontier)
5. Select individual investments to meet my overall asset allocation with consideration of fees, diversification.
6. Rebalance the investments periodically (eg. every year) or when the actual asset allocation differs too much from the target allocation - either by selling investments and reinvesting, or by adjusting what assets new savings are directed into. Bearing in mind transaction costs and capital gains tax effects.
In reality I have a ROI target of 5%-15% for my total networth, excluding annual savings of around $30K. Assuming a CPI of 2%-3% this would mean a real return of around 2% - 12%. But I don't have an overall asset allocation target as I have a large chunk of my net worth tied up in real estate via our home and our rental property, despite preferring to be largely invested in Australian and international shares. The rental property investment was mainly chosen because DW wanted to invest in the property market, and the house - well we both prefer to own our own home rather than rent. I therefore tend to only manage asset allocations within our superannuation account and by having the remainder of my investible assets in stock investments plus some alternative investments (hedge funds, agricultural investments, coins, bullion etc). Given that I have a much larger proportion of my assets in real estate than I would prefer, you'd expect that any additional investments would have been directed towards additional stock purchases, or perhaps some alternative investments. In reality although my personal savings have been directed towards direct stock investments or into my superannuation fund, until recently we had actually been increasing the proportion of our networth tied up in real estate due to our home loan payments reducing the property loan principal over time. We've now got both our home loan and rental property loan setup as "interest only", mainly because DW can't afford her half of the normal P+I loan payments while working part-time, so this will shift our asset allocation
more towards stocks over time.
As you can see, my overall asset allocation is therefore a pretty hit-and-miss affair. So for that reason worrying about fine-tuning asset allocation by rebalancing is a moot point.
Copyright Enough Wealth 2007