Online Resources and Trends
There is a surprising wealth of online resources to help you arrive at your asset allocation. Some are better than others, so it's important to know what to look for and how to interpret each tool's recommendations. There is a list of good tools in Appendix B.
What to Look For
Most asset allocation tools will ask you some basic questions about your investment goals and your time horizon. Be sure you're using a tool you understand and compare the results of a few tools before deciding on your personal target asset allocation.
Don't “time the market” by selling and holding cash when stocks start to go down. Knowing when to get back into the market is very difficult, if not impossible. Timing the market requires that you're right twice — finding the right time to sell and to buy. It's better to plan your asset allocation and stick with it through the short-term ups and downs.
Be wary of a tool that recommends specific investment products. Selling these products may be more the focus of the tool than giving good allocation advice. And avoid tools that ask you to make investment return assumptions or recommend frequent trading. If you're inexperienced at investing, it can be difficult to be sure you're making reasonable return assumptions — the asset allocation tool should have a database of historical returns to do that for you.
Monte Carlo
Most good asset allocation tools use a function known as “Monte Carlo simulation” that helps predict future outcomes using a huge variety of statistical inputs. For instance, rather than assuming that the investment class returns the same amount each year — something that history shows is never the case — Monte Carlo simulation can create a more realistic scenario by projecting performance within a range of investment returns. With Monte Carlo simulation, your asset allocation tool can assume more realistically that sometimes stocks do well and sometimes they don't. Instead of giving you a specific expected return, most tools will give you a more realistic range of returns to expect from a particular asset allocation.
Monte Carlo simulation is a very complex process, but it's not foolproof. As with other computerized programs, you can get bad information out if you put bad information in. Run several different simulations using software programs or web-based allocation tools and compare their results before deciding on an approach for your portfolio.
