Saturday, February 03, 2007

Books on basic investment planning & the role of bonds in an investment portfolio

In response to Anne's comment in my previous post discussing the role of bonds in an investment portfolio, I felt I would discuss bonds and investment planning more succinctly.

I've recently read, and re-read Bernstein's Four Pillars of Investing. I strongly recommend it's discussion of the importance of bonds in an asset allocation plan and the book in general for those looking to create a long term portfolio and investment plan. Warning, it clearly leans away from active investing and stock picking.

Another interesting read, in the same vein, but more practical towards portfolio planning and construction is All About Asset Allocation by Rick Ferri. I strongly recommend reading both books.

The bottom line, and one which Moom, did a great job elaborating more eloquently than I is that a diversified portfolio with rebalancing will have a higher return for a given level of volatility - you want to manage volatility as you grow older (reducing risk when you need the money available). However, I still have the impression that for very long investing horizons (30 years or more) a diversified portfolio with rebalancing is likely to exceed any single asset's performance due to the cyclical nature of asset performance.

This means that those in their 30s or 40s should plan on having a diversified portfolio and rebalance regularly unless they expect to die fairly soon.

For Anne's benefit, Bonds are an effective asset to diversify with against stocks as they usually have a low correlation against stocks. This means that when stocks shoot up or down, your bonds are not likely to follow as far or in the same direction. Other assets like REITs, commodities, emerging markets, small cap value and at times foreign large cap are either less correlated or lightly correlated. The multi-asset class portfolio uses the different asset classes and rebalancing to ensure assets are sold high and bought low with a higher return for a given level of risk (or volatility). Ferri has nice charts that demonstrate the benfits of multiple asset classes over dual and single asset class portfolios.

The key approach to make such a plan work is a very long term investment horizon. A diversified asset allocation plan should assume markets will rise and fall and non-correlated assets can be sold to take advantage of buying opportunities when you rebalance.

Anne, I hope this discussion helped, but Bernstein and Ferri do a better job than me.

Regards, makigourway

1 comment:

Anonymous said...

Thank you very much for the input. I'll be following up on the books you suggest. Who knows how much difference your "nudge" may have over 30 years?