Imaging a chef entering a strangers kitchen, grabbing a few ingredients that are available and then he starts cooking. He doesn’t know what to cook because he has no recipe. He doesn’t know who he is cooking for and what kitchen utensils he has to work with in this unknown kitchen. He might get lucky and cook a delicious meal that pleases the guests there. Most likely tho this situation will not turn out in his favor.
When you think of asset allocation you probably think of what instruments to use to invest your money. But asset allocation includes a lot more factors that have to be considered. In this post we are going to look at which 6 factors you most likely neglect and why you should consider for your own asset allocation.
1. Factor – Start with your WHY
Before researching ETFs and how to allocate your hard earned cash take a step back and define the purpose of your doing. Why are you investing money and what is your goal?
Your purpose is probably to grow your portfolio, profit from compound interest and let the money work for you while you sleep. If that is the case then let me ask you how much do you need?
2. Factor – Don’t run after a carrot on a stick (GOALS)
When do you have enough should be a the center of your WHY. Money can grow and work for you indefinitely therefore you need a clear goal.
“The hardest financial skill is to get the goal posts stop moving two steps ahead – The Psychology of Money by Morgan Housel”
Of course you can alter your goal but take the time to define what enough means for you so that you have a clear purpose.
3. Factor – Personal situation
Investment advice that works for others might not be suitable for you. Income differs depending on your background, job, family fortunes and so on. Do you have significant dept that you need to pay off one day? Will you inherit financial assets in the future or do you own a house?
Calculate your net worth to have a rough idea what your situation looks like if you don’t know.
4. Factor – Death is no fun but consider it as well
Probably the least fun aspect of defining your asset allocation is thinking about your worst case scenario. What happens if you should have a disability and not be able to work anymore. What about a deadly accident?
If you are a family man or woman and other people depend on you then this should be looked at anyway. What will happen to your assets if you exit early, will your partner or loved ones get the money or will it be blocked by the insurance company that sold you a dodgy life insurance?
5. Factor – Choose your tools
To quote Ben Felix, a financial advisor and Youtuber:
“Bad financial advise starts with choosing your tools”
After you defined your purpose, goal and personal situation it is finally time to look at how to invest. Choose your favorite index fund, stock or crypto currency to invest in.
5.1. You are unique and so is your asset mix
Depending on your age, risk profile and personal flavor there are endless possibilities. Therefore don’t just follow advice that you read on your favorite blog or from one of the FI gurus.
This is a very personal thing to do and should be tailored to your own situation.
5.2. There are two things guaranteed in life…
There is death which we already mentioned and there are taxes. If you run a dividend strategy withholding tax plays an important role. Same goes for your third pillar, which when paid out at a later stage can erase the tax savings you had in previous years.
6. Factor – Validating your strategy by a non biased party
Lastly but also very important is testing your plans by a third party. This can be a financial advisor or people on a board that are knowledgeable. This helps you avoid confirmation bias where you look for reasons to validate your ideas. It is also wise to get a different opinion in case you are overconfident about your strategy and maybe neglect certain risks.