Balanced Asset Allocation
For those who want to better manage their investment portfolio and seek a more advanced approach to building a balanced portfolio, Balanced Asset Allocation: How to Profit in Any Economic Climate provides an in-depth treatment of the topic that can be put to use immediately.
Balanced Asset Allocation
The Economic Machine
Bridgewater Associates, the largest and most successful hedge fund manager in the world, pioneered most of the concepts that I will present in this book more than 20 years ago. Bridgewater is at the forefront of economic and investment research and has been refining and testing its concepts over the past two decades. The company has a great understanding of what drives economic shifts and how those shifts affect asset class returns. The first chapter is effectively my summary of its unique template for understanding how the economic machine functions. Bridgewater has released a short animated video that explains their template and related research at www.economicprinciples.org , and I encourage you to visit the site. The core principles presented throughout the rest of the book were also developed by this remarkable organization over the past couple of decades. I know of no one in the industry that has a better command of this subject.
In order to fully recognize today's unique economic climate, you first need to better comprehend how the economic machine generally functions. The goal of this first chapter is to arm you with a command of the basic inner workings of this machine to enable a deeper appreciation of why this topic of building a balanced portfolio is so timely . Insight into the economic machine will also lay the required foundation for an improved understanding of the key drivers of asset class returns . I will refer back to this opening chapter throughout the book because it introduces core, fundamental concepts that impact markets, and therefore portfolio returns .
How the Economy Functions
Constructing the appropriate asset allocation is always a challenge, but it is particularly difficult in the current economic environment. The reason is simple: The United States and many other developed world economies are fighting through a deleveraging process that is likely to last for a decade or longer. Deleveraging is a fancy term for debt reduction or lowering leverage. When the amount of debt in any economy gets too high relative to the ability to pay it back, then the debt burden must be reduced. But what does this really mean and why is it so important? To effectively answer this central question, I will start at the most basic level.
The economy functions like a machine. Money flows through the machine from buyers to sellers. Buyers exchange their money for goods, services, and financial assets. This is what money is used for, and it is only worth something because you can exchange it for goods, services, and financial assets. Sellers sell these items because they want money. Buyers buy these things to fill a need. Goods and services help support their lifestyles while financial assets are used to preserve and increase wealth over time. An economy is simply the sum of billions of transactions between buyers and sellers. An economy grows when there are a lot of such transactions and it stagnates when the flow of money slows. At a fundamental level it really is that simple.
The Short-Term Business Cycle
The ability to borrow money slightly complicates the mechanics of the machine. If borrowing were not allowed in the system, then buyers would only buy what they could afford to pay using existing money. There would be no deleveraging because leverage would not exist. The economy could be more stable, although it may operate below its potential because capital would not flow as efficiently. With borrowing, a buyer is able to spend tomorrow's income today. If I want to buy a good, service, or financial asset and do not wish to (or cannot) pay with cash, then I can simply promise to pay for it in the future. I have created credit. This is what typically happens when you buy a house, swipe your credit card at the grocery store, or promise to pay your friend back