Asset allocation is a topic of great debate in the world of investing and personal finance. The theory of diversification dictates that sensible investors should place different parts of their investments into different assets (equities, bonds, property, business, etc). However, exactly how an investor should allocate their investment into these assets varies depending on who you listen to.

 

 

Asset allocation is currently understood to mean that younger investors should have a larger percentage of their assets in riskier investments which provide high returns (stocks, leveraged rental property, small businesses, etc), whereas investors approaching retirement should be focussed on lower risk investments which have much lower returns (cash, private property, etc).

I personally disagree with this due to the rapidly increasing life expectancy and the very poor returns from cash, but that opinion is a topic for another day. Today, we present an introduction to asset allocation by looking at what historical literature tells us.

 

Asset Allocation – The Oldest Theory

Many people think that the theory of “Asset allocation” is a relatively new idea. However, in reality, the theory of asset allocation (at least in a very primitive form) is thousands of years old.

The oldest record of asset allocation is thought to come from the Talmud, which is a record of debates among Rabbis on the subject of Jewish law (the Torah). This is believed to have been written as early as 1200 BC – a mere 3,200 years ago.

The Talmud states:

“Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.”

Translating this into modern day language, this suggests that:

• one third is invested in land and real estate;
• one third is invested into your own business or through other businesses by investment in shares; and
• one third is kept in cash or bonds.

 

 

More religious texts

The Talmud is not the only writings to discuss asset allocation. Take, for example, Ecclesiastes which is one of 24 books of the Tanakh (Hebrew Bible) and is among the canonical Wisdom Books in the Old Testament. Ecclesiastes 11:2 suggests that you “divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth”.

Whilst this does not specifically outline the exact allocation, it does again promote the idea of diversification in your investments.

Deuteronomy 14:22 also goes on to discuss giving to charity in addition to the idea of asset allocation. “Make an offering of ten percent, a tithe, of all the produce which grows in your fields year after year.”

 

What do the classics say?

It isn’t just religious texts which discuss the idea of asset allocation and personal finance. For example, the lowestrates.ca blog explores the inclusion of personal finance topics in the classics.

Dickens’ “A Christmas Carol” explores the issues of penny-pinching cheapskate Ebenezer Scrooge and the impact that his attitude to money is having to himself and those who surround him.

Shakespeare also gets in on the act in The Merchant of Venice, in which he outlines the severe ramifications of debt. Whilst being set over 400 years ago, its relevance today – especially related to loan sharks and payday loans – is all too striking!

 

What do we think?

For most young people, the concept of asset allocation should be a fairly simple one:

1. If you are in consumer debt (credit cards, car loans, payday loans, etc) allocate all your spare cash to paying it pack.
2. Once you have money to invest (surplus to your emergency fund), you should allocate your cash diversified between rental property and shares (or in your own small business if you are an entrepreneurial soul). For more detail why, check out our article which explores whether you should invest in shares, property or cash. Little should be held in cash beyond your “safety purse” to pay unexpected expenses from your other investments or life in general.

As you become older, your level of diversification should depend on a combination of your net worth, your goals, your health and your proposed spending habits through retirement. However, I’m afraid that in this day and age, the one-third splits highlighted by the Talmud is probably not applicable to everyone!

 

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