Investment Options to Construct Asset Allocation Portfolio

To capture the benefits of diversification and asset allocation, you will want to build a portfolio of several asset classes that are somewhat uncorrelated. You have a few options for building such a portfolio.

• Portfolio of individual stocks and bonds
• Portfolio of actively traded mutual funds
• Portfolio of index funds and ETFs

Portfolio of individual stocks and bonds

If you believe that your picks can beat the market, this might be a good strategy. Bear in mind that most people who think that they can beat the market will fail. Secondly, if you don’t purchase enough different uncorrelated stocks, your portfolio may not be properly diversified and have higher return variance. This is a real concern since investors typically choose stocks based on their expected return instead of considering diversification implications. Finally, beware of racking up high trading expenses if you turn over your portfolio frequently.

Portfolio of actively traded mutual funds

Mutual funds offer a means for easily constructing a diversified portfolio. There are an enormous number of mutual funds to choose from. They cover all asset classes. However, mutual funds suffer because of their higher expense ratios and several other factors which create a drag on their performance. We would caution the investor who believes that he can identify managers who will consistently beat the market. The odds are against you.

Portfolio of index funds and ETFs

When you properly construct your portfolio, you will reap the benefits from diversification and has the opportunity to get performance which will be very close to the market. There is little risk of under-performance in the long term since your objective is to merely match market performance. Your funds should out-perform over 90% of mutual funds in the long term.