Top Portfolio Asset Allocation Investing Mistakes

Portfolio Asset Allocation

Asset Allocation and Investing Mistakes

The portfolio asset allocation mistakes being made in self-directed investing are common and destructive. Studies show portfolio asset allocation is the most important determinant of investment performance. It is at least 4 times as important as the individual investments you put into your portfolio. How you choose to divide your portfolio on a percentage basis to asset categories is crucial to determining both your portfolio risk and return.

Here are the three top portfolio asset allocation investing mistakes made by the self-directed investor. If you can avoid these common mistakes it can significantly lower your portfolio risk and increase your returns.

Ignoring Portfolio Asset Allocation

Most people really don’t understand the importance of asset allocation. Some investors completely ignore their asset allocation even though it is the single most important determinant of investment returns. While picking individual investments such as stocks may be more fun than choosing a proper asset allocation, studies show that asset allocation is four times more important to portfolio performance than the individual investments within a portfolio.  Asset allocation is the first task for any portfolio manager. Choose your asset allocation; then pick individual investments to fit within your asset allocation.

Lack of Attention to Capital Preservation

The lack of attention paid to capital preservation is the most destructive mistake being made by the self-directed investor. For several decades financial advisors have attached increased importance to compounding growth, and as a consequence recommend asset allocations that are too aggressive. Reverse compounding is more destructive than compound growth is advantageous. In other words, a loss of investment capital that devastates future compounding can be more important than the rate of growth. If you lose 50% of your capital it takes a 100% gain just to get back to breakeven. If you lose 10% of your capital it only takes an 11% gain to get back to breakeven.

Maintaining a Static or Passive Management

Maintaining a static or passive asset allocation management is the third common mistake made by investors. A static asset allocation has been touted by many financial experts, financial blogs, and supported by the bull market of the 80’s and 90’s. Buy and hold has failed. The volatility of the past decade has exposed the weakness of this philosophy and produced low or negative returns. In addition, the lack of flexibility inherent in passive asset allocation management can work against capital preservation.

Asset allocation is the key to successful self-directed investing. The remedy for these three mistakes is an active or tactical asset allocation strategy. A tactical strategy allows the flexibility to invest aggressively when there are low risk opportunities available and be more conservative when conditions require. 

How much attention do you pay to your portfolio asset allocation?