Jerry A. Miccolis, CFA, CFP, FCAS, MAAASenior financial advisor and co-owner, Brinton Eaton Wealth Advisors

Dorianne R. PerrucciFinancial author and editor

Learn to:• Use allocation strategies that best serve

your goals

• Balance and rebalance your portfolio

• Maximize returns and minimize risk

Asset Allocation

Making Everything Easier!™

Open the book and find:

• The top asset allocation mistakes

• How to match the right investments with the right accounts

• Ways to successfully manage risk

• Best practices for portfolio rebalancing

• “What if?” investment scenarios

• Historical rates of return on ten asset classes and subclasses

• How to project your financial future

• Guidance for fine-tuning your long-term allocation plan

Jerry A. Miccolis, CFA, CFP, FCAS, MAAA, is a financial advisor, widely

quoted financial author, and expert commentator who has appeared on

CBS Radio and ABC-TV. Dorianne R. Perrucci is a freelance writer who

has been published in The New York Times, Newsweek, and TheStreet.com,

and has collaborated on several investing books, including I.O.U.S.A., One

Nation, Under Stress, In Debt (Wiley, 2008).

$24.99 US / $29.99 CN / £16.99 UK

Business/Personal Finance/Investing

ISBN 978-0-470-40963-3

Go to dummies.com®

for more!

Use allocation strategies of the pros and protect your financial futureYou don’t have to be an investment expert to allocate your assets successfully. This plain-English guide demystifies the process, giving you timely advice on diversifying your investment portfolio to help insulate it against volatility. You’ll see how to develop your personal investment strategy, avoid costly mistakes, and rebalance to generate extra return.

• The ABCs of asset allocation — discover how it works, why to do it, and the level of risk you’re comfortable with

• Explore the different asset categories — from cash and bonds to stocks, mutual funds, exchange-traded funds, and more

• Plan your investment strategy — set your portfolio constraints, outline your financial goals, and select your asset classes

• Choose securities and accounts — select the best ones, understand fees and expenses, and take advantage of tax breaks

• Maintain your portfolio — keep tabs on your investments, know when to rebalance, and measure your results against appropriate market benchmarks

• Go beyond the basics — consider alternative investments (such as real estate and commodities), maximize after-tax results, and work with the pros when you need help

Asset A

llocation

MiccolisPerrucci

Spine: 0.72”

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Asset AllocationFOR

DUMmIES‰

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01_409633-ffirs.indd ii01_409633-ffirs.indd ii 3/26/09 10:43:39 PM3/26/09 10:43:39 PM

by Jerry A. Miccolis, CFA®, CFP®, FCAS, MAAABrinton Eaton Wealth Advisors

and Dorianne R. PerrucciFinancial writer

Asset AllocationFOR

DUMmIES‰

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Asset Allocation For Dummies®

Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com

Copyright © 2009 by Wiley Publishing, Inc., Indianapolis, Indiana

Published simultaneously in Canada

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permit-ted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Trademarks: Wiley, the Wiley Publishing logo, For Dummies, the Dummies Man logo, A Reference for the Rest of Us!, The Dummies Way, Dummies Daily, The Fun and Easy Way, Dummies.com, Making Everything Easier, and related trade dress are trademarks or registered trademarks of John Wiley & Sons, Inc., and/or its affi liates in the United States and other countries, and may not be used without written permission. CFP and Certifi ed Financial Planner are registered certifi cation marks of the Certifi ed Financial Planner Board of Standards, Inc., in the United States. CFA and Chartered Financial Analyst are registered trade-marks of the CFA Institute in the United States. All other trademarks are the property of their respective owners. Wiley Publishing, Inc., is not associated with any product or vendor mentioned in this book.

LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY: THE PUBLISHER AND THE AUTHOR MAKE NO REPRESENTATIONS OR WARRANTIES WITH RESPECT TO THE ACCURACY OR COMPLETENESS OF THE CONTENTS OF THIS WORK AND SPECIFICALLY DISCLAIM ALL WARRANTIES, INCLUDING WITH-OUT LIMITATION WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE. NO WARRANTY MAY BE CREATED OR EXTENDED BY SALES OR PROMOTIONAL MATERIALS. THE ADVICE AND STRATEGIES CONTAINED HEREIN MAY NOT BE SUITABLE FOR EVERY SITUATION. THIS WORK IS SOLD WITH THE UNDERSTANDING THAT THE PUBLISHER IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OR OTHER PROFESSIONAL SERVICES. IF PROFESSIONAL ASSISTANCE IS REQUIRED, THE SERVICES OF A COMPETENT PROFESSIONAL PERSON SHOULD BE SOUGHT. NEITHER THE PUBLISHER NOR THE AUTHOR SHALL BE LIABLE FOR DAMAGES ARISING HEREFROM. THE FACT THAT AN ORGANIZA-TION OR WEBSITE IS REFERRED TO IN THIS WORK AS A CITATION AND/OR A POTENTIAL SOURCE OF FURTHER INFORMATION DOES NOT MEAN THAT THE AUTHOR OR THE PUBLISHER ENDORSES THE INFORMATION THE ORGANIZATION OR WEBSITE MAY PROVIDE OR RECOMMENDATIONS IT MAY MAKE. FURTHER, READERS SHOULD BE AWARE THAT INTERNET WEBSITES LISTED IN THIS WORK MAY HAVE CHANGED OR DISAPPEARED BETWEEN WHEN THIS WORK WAS WRITTEN AND WHEN IT IS READ.

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About the AuthorsJerry A. Miccolis: Jerry’s clients, colleagues, and friends were caught a

bit off-guard when, in 2003, he decided to change careers, from enterprise

risk management to personal wealth management. But, toward the end of

his 30-year stint in the actuarial and risk-management fi elds (including 25

years with the international management consulting fi rm Towers Perrin,

where he eventually led the global enterprise risk management practice),

he had already nearly achieved the two most sought-after certifi cations of

his chosen second career — Chartered Financial Analyst (CFA) and Certifi ed

Financial Planner (CFP). He’s never been happier, helping real people secure

their fi nancial future. A senior fi nancial advisor at, and co-owner of, Brinton

Eaton Wealth Advisors in Madison, New Jersey, Jerry adds his CFA and CFP

designations to his credentials as a fellow of the Casualty Actuarial Society

(FCAS) and member of the American Academy of Actuaries (MAAA). Jerry,

who is also a member of the Financial Planning Association (FPA) and the

New York Society of Security Analysts (NYSSA), holds a BS in mathematics

from Drexel University.

The coauthor of Enterprise Risk Management: Trends and Emerging Practices (The Institute of Internal Auditors Research Foundation) and Enterprise Risk Management: An Analytic Approach (Tillinghast-Towers Perrin), Jerry has

chaired numerous professional committees and is a widely quoted author

and speaker on the subject of strategic risk management, investment

management, and their interrelationship. Jerry has been published in profes-

sional journals (Strategy & Leadership, Operational Risk, Risk Management, Institutional Investor, CFO Magazine, Investment Advisor, and Financial Planning) and in the mainstream media (The New York Times, The Wall Street Journal, The Baltimore Sun, MarketWatch, MSN Money, and Marketwire). He

has appeared as an expert commentator on CBS Radio, ABC TV, and IRMI.

com, the Web site of the International Risk Management Institute.

All of this, though, is what Jerry does between senior softball games, his real

passion. There, Jerry plays third base and shortstop and bats much lower in

the lineup than he thinks he should.

You can read more of his and his colleagues’ investment advice at www.

brintoneaton.com (click Research Corner) and about his softball addiction at

www.casact.org/newsletter/index.cfm?fa=viewart&id=5639.

Jerry A. Miccolis, CFA, CFP, FCAS, is a principal of Brinton Eaton Associates,

Inc., d/b/a Brinton Eaton Wealth Advisors, an investment adviser registered

with the United States Securities and Exchange Commission. No reader

should assume that the book content serves as the receipt of, or a substitute

for, personalized advice from Mr. Miccolis, from Brinton Eaton Associates,

Inc., or from any other investment professional. Please remember that

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different types of investments involve varying degrees of risk. Therefore, it

should not be assumed that future performance of any specifi c investment or

investment strategy (including the investments and/or investment strategies

referenced in this book) will be profi table.

Dorianne R. Perrucci: Dorianne jokes that she’s still looking for the 13¢

that caused her fi rst checking account to bounce. Dorianne, who has writ-

ten for Newsweek, The New York Times, Mediaweek, and TheStreet.com,

began reporting about personal fi nance and investing in 1998 for Jane Bryant

Quinn’s Washington Post column. Previously, she reported for a daily news-

paper, wrote a political column for a U.S. senator, and produced articles

and books for several of the country’s leading charities, including Covenant

House, the Times Square shelter for homeless and runaway youth. She cur-

rently edits and collaborates on investing books, including: The Demise of the Dollar . . . and Why It’s Great for Your Investments, by Addison Wiggin (Wiley

Publishing); I.O.U.S.A., One Nation, Under Stress, In Debt, with Addison Wiggin

and Kate Incontrera (Wiley Publishing); The Ultimate Depression Survival Guide, by Martin D. Weiss (Wiley Publishing); and the AARP Crash Course in Creating Retirement Income, by Julie Jason (Sterling Publishing).

Dorianne, a graduate of Marquette University’s School of Journalism, is a

member of the American Society of Journalists and Authors and the New York

Financial Writers Association. When she isn’t busy explaining the consumer’s

next investment challenge, she continues to search for that missing 13¢.

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DedicationTo you, the average investor, who is curious enough to wonder if a For Dummies book can really help you get superior investment results, like the

pros. Asset allocation, which begins with determining the right (and the

right-size) baskets for your investment “eggs,” isn’t exactly a piece of cake,

but we promise, if you’re determined to learn the recipe, we’ll make the pro-

cess a very satisfying one for you.

AcknowledgmentsIt takes a village to write a book. Okay, not original, but true — you need a

tribe of supporters to make it safely to the “effi cient frontier” of investing.

Jerry Miccolis thanks his coauthor, Dorianne, for her contagious enthusiasm

and offbeat sense of humor — and for constantly nagging him to “Keep

it accessible!” Numerous editorial suggestions from his Brinton Eaton

colleagues — Bob DiQuollo, Ben Jacoby, Jeremy Welther, Jerv Brinton, Nick

Laverghetta, Ellen Clawans, and Abby Scandlen — vastly improved the fi nal

manuscript. Special mention to Marina Goodman, who seemed to take

particular pleasure in offering blistering critiques of early drafts but also

made excellent original contributions and helped prepare many of the

exhibits and examples. They and the rest of the staff — Colleen Betzler, Dave

Hill, Eric Mancini, Doris Merrick, Adrian Fedorkiw, Kim Dibenedetto, and

Pam Trunfi o — graciously picked up the slack for Jerry at the offi ce. Most

important, Jerry thanks Marcella, his wife and muse, for her unfailing

support, encouragement, and understanding, during the nights and weekends

he devoted to this book.

Dorianne Perrucci thanks Jerry, for his patience in explaining technical

jargon and would like to ask him to explain perfect negative correlation one

more time. She thanks her agent, Marilyn Allen, and the entire amazing For Dummies team, especially Acquisitions Editor Stacy Kennedy, who actually

wanted to publish a book on asset allocation; Elizabeth Kuball, project editor

extraordinaire; and Dummifi er Brittain Phillips, whose mysterious ability to

rework text works wonders. Dorianne is also grateful for her family and a

host of colleagues and friends for continuing to cheer her on.

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Publisher’s Acknowledgments

We’re proud of this book; please send us your comments through our Dummies online registration

form located at http://dummies.custhelp.com. For other comments, please contact our

Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax

317-572-4002.

Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and Media

Development

Project Editor: Elizabeth Kuball

Acquisitions Editor: Stacy Kennedy

Copy Editor: Elizabeth Kuball

Assistant Editor: Erin Calligan Mooney

Editorial Program Coordinator: Joe Niesen

Technical Editor:

Louis J. Schwarz, QFP, CFP, RFC

Senior Editorial Manager: Jennifer Ehrlich

Editorial Supervisor and Reprint Editor:

Carmen Krikorian

Editorial Assistants: Jennette ElNaggar,

David Lutton

Cover Photos: © Yiap Lightbox/Alamy

Cartoons: Rich Tennant

(www.the5thwave.com)

Composition Services

Project Coordinator: Kristie Rees

Layout and Graphics: Carrie A. Cesavice,

Reuben W. Davis, Melissa K. Smith,

Christin Swinford

Proofreaders: Melissa Cossell,

Jessica Kramer, Broccoli Information

Management

Indexer: Potomac Indexing, LLC

Special Help: Brittain Phillips

Publishing and Editorial for Consumer Dummies

Diane Graves Steele, Vice President and Publisher, Consumer Dummies

Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies

Ensley Eikenburg, Associate Publisher, Travel

Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies

Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services

Gerry Fahey, Vice President of Production Services

Debbie Stailey, Director of Composition Services

01_409633-ffirs.indd viii01_409633-ffirs.indd viii 3/26/09 10:43:40 PM3/26/09 10:43:40 PM

Contents at a GlanceIntroduction ................................................................ 1

Part I: Discovering the Not-So-Secret Recipe for Asset Allocation ........................................... 9Chapter 1: Understanding Asset Allocation ................................................................. 11

Chapter 2: Weighing Risk and Return ........................................................................... 23

Chapter 3: Making Sense of Asset Classes .................................................................... 43

Chapter 4: Determining the Right Proportions: Your Asset Mix ............................... 65

Chapter 5: Stirring the Mix: Portfolio Rebalancing ...................................................... 81

Part II: Getting Started .............................................. 97Chapter 6: Laying the Foundation for Your Plan ......................................................... 99

Chapter 7: Developing Your Investment Strategy ..................................................... 117

Chapter 8: Creating Your Allocation Plan ................................................................... 151

Part III: Building and Maintaining Your Portfolio ....... 167Chapter 9: Buying Securities ........................................................................................ 169

Chapter 10: Knowing Where to Put Your Assets: Asset Location ........................... 193

Chapter 11: Monitoring Your Portfolio: Rebalancing and

Other Smart Strategies ............................................................................................... 205

Chapter 12: Measuring Your Results ........................................................................... 219

Part IV: Going beyond the Basics .............................. 231Chapter 13: Walking to the Beat of a Different Drum:

Opting for Alternative Investments ........................................................................... 233

Chapter 14: Managing Your Taxes like a Pro ............................................................. 249

Chapter 15: Knowing When to Revise Your Plan ....................................................... 263

Chapter 16: Finding Help When You Need It .............................................................. 277

Part V: The Part of Tens ........................................... 293Chapter 17: Ten Asset Classes and Subclasses and

Their Historical Rates of Return ................................................................................ 295

Chapter 18: Ten Common Asset Allocation Mistakes ............................................... 307

Chapter 19: Ten Questions to Test Your Asset Allocation Know-How ................... 315

Index ...................................................................... 323

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Table of ContentsIntroduction ................................................................. 1

About This Book .............................................................................................. 2

Conventions Used in This Book ..................................................................... 2

What You’re Not to Read ................................................................................ 3

Foolish Assumptions ....................................................................................... 3

How This Book Is Organized .......................................................................... 3

Part I: Discovering the Not-So-Secret Recipe for Asset Allocation ..... 4

Part II: Getting Started ........................................................................... 4

Part III: Building and Maintaining Your Portfolio ............................... 5

Part IV: Going beyond the Basics......................................................... 5

Part V: The Part of Tens ........................................................................ 5

Icons Used in This Book ................................................................................. 6

Where to Go from Here ................................................................................... 6

Part I: Discovering the Not-So-Secret Recipe for Asset Allocation ........................................... 9

Chapter 1: Understanding Asset Allocation . . . . . . . . . . . . . . . . . . . . . .11Figuring Out Why Asset Allocation Is So Important .................................. 12

Encapsulating the Enron story ........................................................... 12

Exploiting the 90 percent solution..................................................... 13

Uncovering the Basics of Asset Allocation ................................................. 14

Balancing risk and return ................................................................... 15

Selecting your asset classes ............................................................... 15

Determining your asset mix................................................................ 16

Rebalancing your asset mix ................................................................ 16

Getting Started with Your Investment Strategy ......................................... 17

Building Your Portfolio and Keeping It True to Your Long-Term Goal ..... 18

Selecting securities .............................................................................. 19

Mastering asset location ..................................................................... 19

Monitoring your portfolio to stay on target ..................................... 20

Measuring your results ....................................................................... 20

Reaching Past the Asset Allocation Basics ................................................ 21

Adding alternatives.............................................................................. 21

Tackling taxes ....................................................................................... 22

Altering your allocation ...................................................................... 22

Embracing expert help ........................................................................ 22

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Asset Allocation For Dummies xiiChapter 2: Weighing Risk and Return. . . . . . . . . . . . . . . . . . . . . . . . . . . .23

Measuring Return .......................................................................................... 24

Total return and its components ....................................................... 24

Nominal return versus real return ..................................................... 25

Understanding time-weighted return versus

dollar-weighted return ..................................................................... 26

Annualizing multiyear returns ........................................................... 27

Accounting for taxes, fees, and expenses ......................................... 29

Measuring Risk ............................................................................................... 30

Differentiating between volatility and risk ....................................... 31

Understanding how volatility erodes return: Risk drag.................. 32

Using statistical measures for risk .................................................... 33

Factoring in your time horizon .......................................................... 35

Evaluating the Trade-Off between Risk and Return .................................. 37

Recognizing that there’s (usually) no such thing as a free lunch .... 37

Heading for the effi cient frontier ....................................................... 38

Chapter 3: Making Sense of Asset Classes. . . . . . . . . . . . . . . . . . . . . . .43Identifying the Traditional Classes .............................................................. 43

Embracing equities: Stocks and stock funds .................................... 44

Getting a handle on fi xed-income investments:

Bonds, bond funds, and more ........................................................ 48

Capitalizing on cash and cash equivalents ....................................... 57

Understanding Alternative Investments ..................................................... 60

Looking at your options for alternative investments ...................... 60

Knowing when to add alternative investments to your portfolio .... 61

Going Global with International Investments ............................................ 62

Chapter 4: Determining the Right Proportions: Your Asset Mix . . . . .65Putting the 90 Percent Solution to Work for You ...................................... 66

Keeping your eye on the important 90 percent:

Allocating your assets ..................................................................... 67

Avoiding focusing on the other 10 percent ...................................... 67

Embracing asset allocation’s guiding principle ............................... 68

Laying the Foundation for Successful Asset Allocation ........................... 68

Understanding correlation ................................................................. 69

Discovering the appeal of non-correlated assets ............................ 70

Finding the holy grail of asset allocation:

Perfect negative correlation ........................................................... 74

Seeking stability and vanquishing volatility ..................................... 76

Recognizing the Most Important Features of an Asset ............................. 79

Chapter 5: Stirring the Mix: Portfolio Rebalancing . . . . . . . . . . . . . . . .81Getting Your Free Lunch with Rebalancing ............................................... 82

Understanding the Power of Rebalancing .................................................. 83

How rebalancing works: Unlocking the energy

of the periodic table ......................................................................... 84

Making volatility work for you: Volatility pumping ......................... 87

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xiii Table of Contents

Memorizing the mantra: How rebalancing

forces you to buy low and sell high ............................................... 93

Being a contrarian: Making sure you have the

right mindset for rebalancing ......................................................... 93

Following the Right Rebalancing Schedule ................................................ 94

Rebalancing on fi xed calendar dates ................................................. 95

Planning your rebalancing for the greatest opportunity ................ 95

Part II: Getting Started ............................................... 97

Chapter 6: Laying the Foundation for Your Plan . . . . . . . . . . . . . . . . . . .99Seeing Your Investment Horizon Clearly .................................................. 100

Setting Your Return Objectives ................................................................. 103

Making Decisions about Your Risk Tolerance ......................................... 103

Evaluating your experience .............................................................. 105

Considering risk questionnaires and other tools .......................... 106

Setting Your Portfolio Constraints ............................................................ 107

Recognizing positions you won’t get out of ................................... 108

Identifying investments you won’t consider .................................. 108

Limiting your exposure to certain asset classes ........................... 109

Reviewing Your Tax Situation .................................................................... 110

Being mindful of your current and future tax brackets ................ 110

Looking for opportunities in prior tax returns .............................. 111

Considering which of your assets are in tax-deferred accounts .... 112

Taking Account of Special Circumstances ............................................... 112

Protecting your assets from lawsuits .............................................. 112

Protecting your estate from taxes ................................................... 113

Simplifying your holdings ................................................................. 114

Chapter 7: Developing Your Investment Strategy. . . . . . . . . . . . . . . . .117Understanding the Lifetime Cash-Flow Projection .................................. 118

Getting a feel for the basics .............................................................. 118

Recognizing the link between your asset allocation

and your Lifetime Cash-fl ow Projection ...................................... 119

Coming Up with an Outline for Your Long-Term Financial Plan ........... 120

Assets .................................................................................................. 121

Liabilities ............................................................................................. 123

Income ................................................................................................. 124

Expenses ............................................................................................. 128

Putting It All Together: Making Lifetime Cash-Flow Projections ........... 134

Salary and other income ................................................................... 138

Expenses ............................................................................................. 138

Investment returns ............................................................................ 139

Taxes ................................................................................................... 139

Savings or withdrawals ..................................................................... 139

Assets .................................................................................................. 141

Liabilities ............................................................................................. 141

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