More assets in an asset allocation?

Q – Every book I read talks about asset allocation in terms of allocating to Stocks, Bonds, and Cash. Wouldn’t it be better to allocate across even more asset types?

A – It’s a yes and no answer. First, the purpose of asset allocation is to mitigate risk by using several “less correlated” assets, and to reduce risk by rebalancing back to the desired allocation every so often, generally once a year. So, yes, if it were possible to find and use other asset categories, that would be a good thing if...a big if....they are not more risky or have very low historical returns. A Latin America stock fund may be less correlated to U.S. stocks, but the volatility is higher (and they cost more to own with higher fund expenses). On the other hand, a Real Estate Investment Trust (REIT) fund is basically owning commercial real estate or other properties so that might be a candidate to allocate some small percentage of your portfolio to. However, if you own an S&P 500 fund, it already includes about 2% in real estate.

When an investor goes too far trying to include lots of different assets, they can run into problems. Rebalancing requires buying and selling percentages which can be difficult with some other asset classes. 10% of a house can’t easily be sold, nor 8% of a Gold Bar. That said, you can hold real estate and commodities in funds rather than physical assets, if desired. If you felt that your asset allocation should include 10% in real estate and 5% precious metals, add them as ETFs instead of physical assets. Remember though to be careful in selection of funds and how they represent the asset class; a physical gold bullion ETF or a gold miner ETF; are two different things. An asset that is pure speculation, such as cryptocurrency or one based on earnings that are returned to you as dividends. Regardless, one should be careful not to allocate too large a percentage to very speculative or niche asset classes.