Asset allocation is a foundational principle when it comes to building a sound financial foundation against financial storms. The type of financial foundation you build determines your capability to withstand financial storms which are inevitable. Markets experience boom and bust cycles, economies boom and go into recession, sometimes depression. Investments yield good returns and sometimes go sour. People make money and people lose money. You cannot expect to win all the time in the world of business and investment. Sometimes the unexpected happens. Like the daily rising and falling of tides, this is the natural cycle of life. There is nothing much you can do about it, except have a plan for every season of life by building a solid financial foundation.

People often wonder where to start from as they begin to build their financial foundation. The two critical components are getting a financial education and building in the right sequence. Without both, you will easily fall into the trap of greed for high returns which has wrecked many financially. Proper asset allocation assists you to channel your savings and investment capital into building a solid asset base that will withstand financial storms which are inevitable.

A proper financial foundation is made up of three plans which go with different nomenclature. I choose to call it security plan, growth plan and rich plan. In some circles, it is known as financial security, growth and dream plans. Rich Dad calls it the plan to be secure, comfortable and rich. Whatever name you choose to call it, you need the three plans in place in the right sequence in order to weather financial storms. This is achieved through asset allocation.

Your security plan is made up of assets that yield fixed guaranteed returns. These are typically made up of interest yielding money market accounts, treasury bills, bonds etc. The rate of returns is relatively lower than other asset classes, but is guaranteed and virtually risk free.

The growth plan, as the name plan implies is made up of assets that appreciate in value and also generate a higher rate of return. This plan is more attractive to rookie investors because of the capital gain and higher rate of return. Assets in this plan are typically made of stocks, real estate etc. The risk profile in this plan is also much higher as not only are the returns on investment not guaranteed, but also the return of your investment. A market crash can virtually wipe out your portfolio.

The rich plan is where you finally attempt to strike it rich. The risks here are sky high and so are the rewards. You can win all and lose all. Assets in this plan include investment in start ups, starting your own business, high leverage real estate investments etc. The stakes are very high, so are the potential payoffs. If the investment goes wrong, it can send you straight to bankruptcy.

By effective use of asset allocation, you first of all build your security plan to the point that interest income from your security plan is enough to cover your basic monthly expenditure, including rent, groceries and bills etc. When you get to this point, you can choose not to work again if you so desire. You have achieved financial independence.

You don’t have to wait until you achieve financial independence before start building your growth plan. Simply focus on your security plan while gradually putting your growth plan in place, allocating majority of your funds to your security plan while acquiring the necessary financial education, intelligence and experience required in the world of business and investing to building a growth portfolio. With your security plan in plan, you can shift focus and allocate more funds into growing your growth portfolio. As you achieve your target with your growth plan, you gradually channel funds into your rich plan. The guiding principle is never to risk everything on one single investment no matter how fool proof it seems. As you grow older, it becomes increasingly difficult starting all over again as a result of risking it all and losing it all.

Starting with the security plan allows you to gain time to invest in your financial education while investing in a no risk scenario. Your security plan is the foundation up which all other plans rest. If the market crashes or you lose your job, your security plan if properly funded can keep you going indefinitely until you decide what to do next. With a security plan in place, you can take bigger risks in the market, knowing that if all fails, you have a roof over your head, food on your table and your kids do not have to drop out of school. With your security and growth plan is in place, you can attempt ultra high risk investments knowing full well your security and comfort is not on the line. It is money you can afford to lose. You can only achieve this through proper application of the principle of asset allocation.

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