Most people think that security selection and dividend analysis is the most important thing when it comes to building a portfolio. However, research has proven that security selection is only a small piece of the larger puzzle. In the book The Only Three Questions That Count, Ken Fischer talks extensively about only 30% of portfolio performance as coming from asset selection. An article in the most recent edition of Forbes (June 2, 2008), titled The Big Picture explains what is more important than asset selection: asset allocation and keeping fees low.
The article is best summed up in the following statements:
What investors should be doing when panic is in the air is tuning out the market’s day-to-day distractions and focusing on multidecade goals. That means sticking to two basics: deciding what asset categories to own and finding ways to own them cheaply. [Emphasis mine]
That is good advice. My experience has shown that asset allocation is crucial in helping to manage my portfolio’s risk. Over the long term, my expectation is that my carefully chosen asset allocation will provide me better returns than the securities I hold. That means my balance of equities to bonds will provide me with similar returns as an all-stock portfolio, but with much less volatility. Please do not get me wrong, proper dividend analysis is crucial to making sure I don’t blow my brains out on any one selection. However, with enough stocks in enough sectors and with enough fixed income assets I will be much better protected to whether a downturn like the one we have been experiencing.
In addition, fees are equally important. My biggest beef with the rest of the Forbes article is that they suggest mutual funds and do not list the management expense ratios of the funds. They provide some sort of cost per $100, but I think that is a way to hide the real cost of the fund. In addition, they also list load funds which are a complete ripoff – there is a sales charge for the privilage of buying the funds. If you want to avoid individual dividend analysis and security selection, then choose low cost index funds and avoid the mutual funds, especially the ones that pay a sales charge to commissioned sales people.
So, when you are deciding on your portfolio strategy don’t jump right into the fun stuff of analyzing and choosing dividend growth stocks. Instead, step back and determine your asset allocation first and then determine the low cost ways to fill out that target allocation. Over the next 20 years, it will all pay off.Google+
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