Building an Investment Portfolio is a lot like making salsa

Great salsa is all about diversification. Only by adding diverse ingredients together can we achieve the desired outcome. However, there are some ingredients in salsa that most of us would never want to eat individually, like hot peppers or Tabasco sauce. But, without the "hot" ingredients the salsa would be flat.

Similarly, investment portfolios should include a wide variety of diverse ingredients or "assets". Mutual funds that invest in US stocks are a core ingredient for a portfolio, analogous to tomatoes in salsa. But, US stocks are only one asset class. More asset classes are needed. We need non-US stock. But, even after adding non-US stock, our portfolio still only has "stock" ingredients.

Let's add US bonds. Bonds behave differently than stocks. Now we're starting to achieve some meaningful diversification. But why stop there? We should also add non-US bonds because they behave differently than US bonds. Now we have a portfolio with stocks and bonds, both US and non-US. We've made a good start, but we're not done. The "salsa" is still relatively unsatisfying.

How about real estate? Yes. But you've heard real estate mutual funds are risky. Sure, if that's the only mutual fund you have in your portfolio, but when a real estate fund is added as an ingredient in a portfolio that includes other asset classes it provides wonderful diversification…just like hot peppers in salsa. With US and non-US stocks, US and non-US bonds, and real estate our portfolio is becoming interesting.

What about adding commodities to the portfolio? Absolutely. A commodities mutual fund represents the Tabasco sauce in our portfolio. You may not want a portfolio that only includes commodities, but they are a wonderful ingredient in a diversified portfolio. To make the portfolio even better, we'll also add a natural resources mutual fund. A commodities fund invests in oil and natural gas, agriculture products (wheat, corn, sugar, soybeans, etc.), industrial and precious metals, cattle and hogs. A natural resources fund typically invests in companies involved in the extraction, transportation, and processing of commodities, such as oil exploration firms, companies that produce heavy equipment or machinery, companies that transform raw resources into value added products, forest products companies, railroad companies, real estate companies, etc.

Cash? Yes, every portfolio needs some cash (e.g. money market fund). Cash is like salt. Not very exciting by itself, but it sure makes everything else taste better. Salsa without salt is a bad idea.

Each investment asset adds an important dimension to the portfolio because each asset behaves differently. This diversity is vitally important in salsa…and in portfolios.

7Twelve^TM Asset Allocation Model

7TwelveTM Asset Allocation Model
Approximately 65% of the Portfolio Allocation in Equity and Diversifying Assets				Approximately 35% of the Portfolio Allocation in Bonds and Cash
US Equity	Non-US Equity	Real Estate	Resources	US Bonds	Non-US Bonds	Cash
Large Companies	Developed Markets	Global Real Estate	Natural Resources	US Aggregate Bonds	International Bonds	US Money Market
Medium-Sized Companies	Emerging Markets		Commodities	Inflation Protected Bonds
Small Companies

The above is an excerpt from the 7Twelve Report.