Frugalnomics

Asset allocation is a process that begins with an assessment of the person that will own the annuity and their personal profile. This personal profile will include several elements specific to that person including such things as time horizon for the investment, purpose of the investment, risk tolerance of the owner, experience with investing, beneficiaries, total net worth, personal interests, etc. The asset allocation will then be tailored to fit that profile as best it can.

There are numerous models that can be used to complete this process but there are some basic elements in all of them. There are three asset classes: equity annuity rates, fixed annuity rates, short term annuity rates. These are sometimes referred to simply as stocks, bonds and money.

Equities come in three sizes (subclasses) – Large Cap (>5bn), Medium Cap (1-5bn), and Small Cap <1bn), – and three flavors which include value, growth, blend of value and growth. Equities can be further categorized geographically as domestic or foreign. The equity allocation is considered to be part of the more risky portion of the allocation, but has the most upside potential, in line with the conventional risk/reward tradeoff. Foreign equities have traditionally been considered more risky but as the world becomes more homogeneous, that is become less the case. Sector choice may also be a consideration, especially if there is room left for risk. Some folks have interests in technology, agriculture, eco-friendly (green), etc.

A feature of owning assets in an annuity, is that reallocation and rebalancing can be accomplished without incurring tax exposure. Stock trades can be made and profits taken without a taxable event each time. This allows allocation decisions to be made without consideration for recognizing gain, especially ordinary income in the case of short term gain.

Fixed income is considered to be a more conservative element where risk is minimized but not eliminated. These investments are typically in the form of bonds of various types – government, private, commercial, etc.

Short term includes money markets, CD’s, T-bills, etc. This class is primarily for liquidity and a place to store proceeds from trades and incremental additions to the Portfolio.

Another element of asset allocation is that it may change over time and must be continually reevaluated to insure the risk profile of the annuitant is still being mirrored. In fact more often in cases where major life events occur such as marriage, divorce, family death, win the lottery, etc. The investment mix should be reviewed at least annually and most annuity companies have investment management systems in place that rebalance as often as quarterly.

Asset allocation and continuous maintenance and updating is critical in achieving a successful outcome with any retirement strategy, especially when dealing with a constantly changing environment. This is the responsibility of an experienced agent using the computer program that constantly monitors the account. Whenever the assets get out of balance due to changes in performance, the advisor monitoring the account will be alerted and can deal with correcting it.

One of the issues that created a good deal of the “havoc” in the investment world in the past was a failure to manage asset allocation. When the housing bubble “burst” many investors found their portfolios were too dependent on a continuing upward march in that sector. One would have expected that more would have learned from the previous tech bubble where tech got overbought in many portfolios which fueled their unsustainable rise in value.

Asset allocation is a prime responsibility of the professional advisor that is chosen with care before entering into any agreement for managing your assets.