Asset Allocation and Diversification
Asset Allocation is a key investing concept. By allocating a portfolio to different asset types (eg stocks, bonds and cash), the portfolio will be less volatile and shielded from the risk of a specific asset type. Historically bonds have gone up when stocks have gone down and vice versa. Diversification on the other hand is the spreading of your investment across several assets, so that no one asset can crater your portfolio rate of return. Asset Allocation and Diversification have meaning for the Winevestor, both in terms of how much of a full investment portfolio should be allocated to wine, as well as how to do a wine allocation within a wine portfolio.
In conventional investment portfolio theory there are a number of ways to categorize a portfolio. There are:
- Asset Type: Stocks, Bonds, Cash
- Geography: US Domestic, International, Global, Emerging Market
- Sector: Consumer, Energy, Technology, Transportation, Industrial, etc
- Company Characteristics: Small/Blend/Large Capitalization and Value/Growth Styles
The classic way of showing this is the style box (popularized by Morningstar) :
A financial advisor guides the investor into an allocation along these axes, depending on the investor’s appetite for risk and on when the funds are needed. Because large cap are more stable than small cap stocks, a general rule of thumb is to have 67% in large cap and 33% in small cap. Across value and growth the split is often 50%/50%.
There are two ways to determine how much to invest in wine: with the heart or with the head. The heart rationale is that you ‘lay down’ twice as much wine as you need: half for drinking and half to pay for wine that is being drunk. This approach allows the Winevestor to claim that they are not paying anything for the wine they drink, always a good position when the debate is about spending $3,000 to purchase wine, that will not be touched for a decade. In reality, of course this argument neglects the opportunity cost of the money, while the wine is maturing, the tax that may be due and the costs of buying, storing and selling the wine. However, for the investor with a small portfolio, and who is buying a few bottle
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