How To Allocate Your Money for Maximum Returns & Minimum Risk
By: Adam Khoo
So with all these money multiplication strategies, where should you
put your hard earned savings? How should you allocate your funds to
generate maximum gains yet minimize your risks?
I am sure you have heard of the term 'don't put all your eggs in one
basket.' Even though you are going to learn how to achieve minimum
risk & maximum returns in each basket, it is still wise to allocate
your funds into different instruments with different targeted
holding periods. In times of emergency when you need the cash, you
can be sure that all your funds are not stuck in one place.
Now, here is an important disclaimer. In most financial textbooks,
they advise diversifying your funds into many different investment
vehicles like bonds, stocks, mutual funds, money markets instruments
as well as spreading your money across numerous different sectors
and different countries to diversify your risks. To an average
investor who has low financial competence and needs the wide
diversification to lower risk, this makes sense. However, while this
kind of broad diversification guarantees low risk, it also
guarantees low returns of 5%-8%.
I personally do not follow this strategy. Warren Buffett advises
that 'broad diversification is used by people to protect themselves
against their own ignorance.' If you know what you are doing (high
financial intelligence), you should concentrate your portfolio into
equities (stocks & mutual funds) as they achieve the highest return.
And you can achieve low risk not by simply spreading your money
around, but by your competence of knowing which funds and stocks to
pick.
So, the strategy I am going to share with you would be deemed highly
risky by the general financial advisors and bankers. Again, it's
because most investors lack the competence to do otherwise. However,
with the strategies and knowledge you gain, you will prove to
yourself that it is actually low risk, high return strategy.
Knowing how to allocate the money you save is the single most
important decision that will lead to your financial goals. You
should take your monthly savings of 15-20% and allocate it to four
money baskets. These are the security basket, growth basket, high
growth basket and the luxury basket. Let me explain each of these.
1. Security Basket (Target Return of 1.5%-4.5%pa)
This first basket is as the name implies, for your security. The
funds in this basket grow just enough to keep pace with inflation.
However, they are there in case of emergencies. If you suddenly lose
your job, experience a salary cut or suffer a setback in your
business, you know that you will have access to these funds anytime
to see you through.
This basket should include cash, fixed deposits/certificates of
deposits, personal housing, insurance & capital guaranteed funds.
2. Growth Basket 1 (Target Return of 8.51%-20%pa)
This is the basket where you build your net worth & positive cash
flow assets that will lead you to financial freedom.
This basket is where you put your money into index funds, Exchange
Traded Funds (ETFs) and mutual funds. You should also divide your
funds between the US market and Asian markets. Although mentioned
earlier that Asian equities have disadvantages, we cannot deny the
huge growth opportunities that Asia offers (especially India and
China).
3. Growth Basket 2 (15%-25%)
This is the basket where you ACCELERATE the building of your net
worth & positive cash flow assets that will lead you to financial
freedom. Once again, you should not have to touch this money for
five to ten years to let the power of compounding work its magic.
This basket is where you put your money into a winning portfolio of
ten to twelve company stocks. And again, you should hold some Asian
stocks as well as US stocks.
4. Luxury Basket (0%)
Your luxury basket is where you save up to indulge in your dream
assets. This is money that you can afford to spend on things that
are fun like: Upgrading to a dream house, luxury cars, jewelry,
boats and other luxuries. Again remember from the chapter on 'How
the rich manage their cash flow' that the money to be used for
luxuries should not come from your primary source of income, but
from the passive income generated from your positive cash flow
assets