Asset Allocation Challenge

Asset allocation is the key element for a successful investment plan. Under the current market conditions, having a proper asset allocation mix brings a conventional benefit of diversification and safeguards the portfolio to some extent. However, earning an absolute return on any given portfolio is a huge challenge for at least the foreseeable future. Contrary to expectations, pretty much all asset classes have performed anywhere between ugly to just plain bad, with one noted exception - bonds. Not considering cash asset class, out of the five contemporary asset classes of stocks, bonds, real estate, commodities and alternative assets, only bonds class has posted positive returns for the last twelve months.

What to do in such a tricky market environment? How to position your portfolio for a potential upside, yet protect it from a major downside? Due to significantly diminished value of an equity portion, stocks asset class is significantly underweight as a percent of the total portfolio. So, the obviously right thing to do is to raise the equity portion by taking some weight off of bonds portion as that is overweight now. Taking the weight off of bonds is certainly the right thing to do. However, raising the equity portion is debatable, since there are still major economic risks out there. So, what is one gotta do?

Increasing real estate and alternative asset class, perhaps even commodities class, allocation to the maximum level is one solution. Alternatively, instead of taking the weight off of bonds class, simply reduce the maturity level in the bonds class as this class is prone to suffering as the economy improves. A shift from long-term bonds to short to intermediate term bonds will protect that portion better, yet the income generated from this class will be insignificant. Is that acceptable? One has to choose between the greater upside potential with greater downside (by increasing equity stake) or better protection (by shifting from long-term bonds to short/intermediate-term bonds). What do you prefer between the two aside from the first solution?