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Asset Allocation

This is also referred to as economic hedging and can be defined as a conservative method of diversifying assets so they will react different under various economic conditions.

Successful investing can be based on 4 key characteristics as follows:
  • Discipline
  • Patience
  • Historical Prospective
  • Common Sense Strategy

Reasons for using asset allocation:

  • History repeats itself
  • No one can predict the future – not even the experts
  • Comfort in knowing you have not painted yourself in a corner
  • Acts as a hedge against financial risks you cannot control

To protect against risks, the risks must first be identified and then investments set up to diversify around them. Listed below are the main types of economic environments.

  • Hyper Inflation (100%+/year)
  • Double Digit Inflation (10%+/year)
  • High Inflation (5 to 9%/year)
  • Normal Inflation (2 to 4%/year)
  • Recession
  • Depression

Now lets look at a couple examples of how various investment types do in these differing environments.

In a depression we see the following:

  • Stocks go way down (85-90%)
  • Real Estate – Also tends to go down
  • Interest Rates – drops to very low rates
  • Unemployment – this goes way up
  • Property – material things tend to lose value
  • Bonds – These do well, as bonds tend to vary inversely with interest rates.

Recommended investment in a depressed economy then would be high quality, intermediate term (2-4 year), discounted corporate bonds.

On the other hand in a Hyper-Inflation economy the situation would be completely different.

  • Stocks – do well for a while, then collapse
  • Real Estate – depends, because it is often bought with debt
  • Gold – this has done well in keeping its value in hyper-inflation conditions

Of note, the last time the US was in a hyper-inflation economy was during the civil war. However several other countries have been in this situation in recent years.

Now that we know how the environment can affect different investments, let's look at what investments are best for each environment and how to protect your investments in these changing economic times with economic hedging.

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Bonds - See how they can fit into your portfolio
Mutual Funds - Learn the basics
How to select a Mutual Fund
How to build a great stock portfolio
Diversify with real estate
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