Asset allocation is simply the way you allocate the many asset classes within your portfolio. These asset classes include the MutualFundAlliance.com Model Portfolios but also include other assets, such as your direct investment stock or bond portfolio, your home or life insurance policies, and/or your retirement plan.

For example, a married couple in their fifties may choose to allocate their investment portfolio among the MutualFundAlliance.com Model Portfolios in the following way:

• Cash Reserves: 20%
• MFA Fidelity Model Income Portfolio: 40%
• MFA Fidelity Model  Balanced Portfolio:20%
• MFA Fidelity Model Growth Portfolio: 20%

The objective of asset allocation is two-fold, to increase overall portfolio returns while minimizing portfolio volatility. The first step in achieving these objectives is to determine how much risk you can afford to take. As we have discussed in the MutualFundAlliance.com Investor Library, there is a tradeoff between risk and return. As expected portfolio returns increase (as measured by the portfolio’s Average Annual Return), so does the portfolio’s expected risk (as measured by the fund’s Standard Deviation or Beta).

Before you begin investing, you need to consider your savings goals. Most people have many goals for which they are saving or have integrated these goals into an overall financial plan. These goals include such things as retirement, college tuition, a downpayment for a second home, or saving for an annual vacation. Therefore, your investment strategy will depend primarily on the time horizon of your particular savings goals.

1.1.1     Determining Your Current Asset Allocation

When considering which type of financial product to purchase, it is important to first calculate how the assets you currently own are distributed. This is a relatively simple calculation.

• First find the total value of your portfolio.
• Divide that number by the value of your holdings in each asset class.
• This will give you a percentage of the total you have devoted to each particular class.
• Based on what you have learned about the different asset classes and then factoring in your own investment objectives, you should be able to make informed decisions about where to invest your dollars going forward.

Let's look at an example. A portfolio is worth $100,000 and contains only stocks and mutual funds. The stock value is nearly $75,000, whereas the mutual funds are at $25,000. That means that the total portfolio is weighted very heavily in stocks in relation to other holdings - 75% to 25% to be precise. If what the investor is looking for is an aggressive strategy and has a high-risk tolerance this may be an appropriate strategy. If, on the other hand, the investor is looking to invest more conservatively, then reconsidering the weighting of the portfolio is in order.

1.1.2     Your Optimal Asset Allocation

To help our members determine their optimal asset allocation depending of their savings goals and time horizon, we continually update the MutualFundAlliance.com Asset allocation table. In the MutualFundAlliance.com Asset Allocation Table, we present models of how much to invest in each portfolio based on your time horizon. The first column should be used if your savings goal is for your retirement. For example, if you are in your fifties, our asset allocation models suggest that you should invest 15% of your savings in one of our Model Growth Portfolios to help ensure that you maximize the power of compounding returns over the next 15 years. We have recently increased this allocation and will likely increase it over the next few months as the market turns around. In addition, our asset allocation models suggest that you should invest 45% of your portfolio in the one of the MutualFundAlliance.com Balanced Model Portfolios. We have recently lowered our recommendation for the amount to keep in our Model Income Portfolios to 25% of your portfolio. With interest rates at their current low levels, bond funds have risk of declining in value as yields increase. Finally, in the case of an emergency, you may want to keep 15% of your retirement savings in a money market fund. Of course, the amount that you may want to keep in money market funds will differ depending on the size of your portfolio and your average monthly expenses. Keep in mind that money market funds are not FDIC insured and you may want to keep your real rainy day funds in a bank.

The MutualFundAlliance.com Asset Allocation Model changes over time with market conditions. In addition, you may want to re-visit your portfolio as your time horizon, income, or net worth change or if there are any other significant events that take place in your life. If your net worth increases significantly, you may want to invest a larger portion of your savings in our Growth Portfolio and less in money markets. For example, consider John who has a net worth of $100,000. It is reasonable for him to have $20,000 invested in money markets in case of an emergency, such as unemployment. On the other hand, if John was worth $10 million it would be overkill for him to have $2 million sitting in money market accounts.