Thursday, October 23, 2008

Asset Allocation Change

I'm currently reading The Brainwashing of the American Investorby Steven Selengut. In the book he recommends using two asset classes: fixed income and equities, in a proportion suitable for your personal situation. He also recommends basing the asset allocation on a working capital model, where working capital is defined as the total cost basis of the securities and cash in an investment portfolio. Working capital is increased by dividends, interest, realized capital gains, and deposits. Working capital is decreased by realized capital losses and withdrawals.

Currently, my covered call portfolio uses two asset classes based on working capital: 10-20% cash and 80-90% equities. After reading the book, I've decide to change my asset allocation into three asset classes: 10% cash, 10% fixed income, and 80% equities.

For the fixed income portion, I've decided to use TIP, an ETF that tracks the Lehman Brothers U.S. TIPS (Treasury Inflation Protection Securities) Index. TIP pays a monthly dividend, currently yielding over 9%. Options are also available for TIP, so I plan to sell OTM covered calls in addition to collecting the dividends. The goal is to slowly accumulate shares in TIP up to 20% of working capital. This should provide a fairly stable source of income.

For the equity portion, I'll stick with my current strategy of investing in dividend paying companies selling at a discount to intrinsic value, and selling covered calls.

The cash portion will be reserved for making any necessary adjustments to the covered call positions in both the fixed income and equity positions.

Hopefully, this change in asset allocation will provide some additional stability to the monthly income generated by this portfolio.