Asset allocation maximizes wealth accumulation

"On average, a man with his feet in the oven and his head in the refrigerator is quite comfortable."

Ah, yes, we all know the problem with averages. And that's the rub if one takes too literally the comments by Warren Buffet that we wrote about last month. The conclusion he reached in his article was that an average 7 percent investment return is likely for next long-term investment cycle.

I commend Mr. Buffet for his part in trying to help investors manage their ex-pectations, especially those who believe that the halcyon days of NASDAQ monster returns will be back soon.

(Many retired investors have built-in expectations of such high returns that their retirement withdrawal rates have, in concert with the markets' two-year de-cline, caused their principle to drop to very uncomfortable levels. One retiree we met with a few years ago chose to place his assets with a mutual fund salesman who based the retiree's withdrawal on a 15 percent annual investment return because that was the return shown for the previous three years in the marketing material. I have wondered often whether the retiree has had to go back to work.)

But averages can be very deceiving; otherwise the oven/refrigerator man would be quite comfortable. An average is a single value that represents the general significance of a set of unequal values. By definition, an average number must have a number or numbers both greater and higher.

Thus, a range of annual returns will continue. The investor's goal is to minimize the below-average annual returns and maximize the above-average return years.

Or better, change the word "years" to "periods," since, as we discussed last month, investment trends and issues do not automatically change when the calendar rolls over from Dec. 31 to Jan. 1.

The investor's task is to recognize and take advantage of those unequal values in a way that will reward him by positively altering his average return. Of course, if an average of 7 percent over the next X number of years sounds good to an investor, he might ask, "Where do I lock up a safe 7 percent return?" That's a problem, since the last time one could do that with impunity was 1997 when the 30-year Treasury was yielding in excess of that amount.

But all may not be lost. If Buffet is right, then why not be satisfied with the performance of the markets and acquire an index fund? Better yet, what about a portfolio of several index funds, such as the Russell 2000 and S&P 500 and NASDAQ 100? Isn't it a good idea to allocate one's assets across several types of investments?

For most investors it is an excellent idea, but it needs to be taken a few steps farther. We are believers in asset allocation. It has proven effective for long-term investors who are serious about managing risk and consistency of returns, and who appreciate the dangers involved in having too many eggs in too few baskets. And while space limitations preclude presenting all the positives (and negatives) of the approach, suffice it to say that it is a much more rational method than simply buying arbitrarily selected stocks or one or more index funds.

Done properly, asset allocation is based first of all on the investor's risk tolerance and goals. Then eight or more asset classes and types are acquired in appropriate percentages consistent with the investor's risk tolerance. The styles and types generally include large- and small-cap growth and value issues, foreign equities, and bonds (government, corporate, high yield), and a cash equivalent.

For large portfolios, this can be accomplished with individual issues; for portfolios of less than $200,000, exchange-traded funds, closed-end funds or open-end funds are preferred in order to provide adequate diversification within each asset class/style.

Does it guarantee that the 7 percent re-turn will be beaten? Nope. There are no zip, nada guarantees that anyone can offer in investing, other than the government's guarantee on the timely payment of principle and interest on its obligations, by virtue of its unlimited ability to tax the whatever out of us if necessary.

Is it as exciting as trading stocks short term? Not even close.

Does it work? Yep.

Talk with your financial professional about how asset allocation might work for you.

But bear in mind that there are those in the business who are more interested in trading stocks than in a disciplined method of accumulating and protecting wealth using asset allocation.

One last, totally unrelated, thought: If you agree with me that over the past 20 or so years the network news has been increasingly presented with a liberal slant, you will want to read Bernard Goldberg's "Bias," a book not likely to make it into Dan Rather's library.

Let me know what you think of it.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Ques-tions or comments can be directed to him by mail via The Springfield Bus-iness Journal, 313 Park Central West, 65806 or by e-mail at sbj@sbj.net.)