Devoted to understanding the basics and fundamentals of investing

Remember that asset allocation is the most important decision you make about your investments.  It determines how much risk and return you are likely to get from your investment portfolio. 

We have recently come through a period of low returns by historic standards.  People are searching for return.  One place they have been finding them are in "Alternative Investments."  Alternative investments are securities beyond the typical portfolio mix of US stocks and bonds.  They include things like precious metals, emerging markets, developed markets, real estate, commodities, etc.

Jeff D. Opdyke wrote a column in the Wall Street Journal on April 26, 2006 on the limits typical investors might use when investing in alternative investments.  He gives limits consistent with conventional wisdom and prudent use of risk.  It turns out there is a significant body of research on the topic.
The object of asset allocation is to diversify your risk in asset classes that have correlations of less than one.  Correlations close to zero or negative correlations allow you to add volatility and hence return while lowering the overall risk in the portfolio.  Simply stated, some things will be going up to offset the losses in assets that are going down.

Some alternative assets have the correlation characteristics we desire.  We can add proportionally more of these.   The higher the correlation (closer to one) the less of an asset class we want to add.  We also need to be aware of the risk (volatility) of the assets.  Professionals use software to input all this data to achieve an optimal portfolio allocation.

Mr. Opdyke recommends between 10% and 30% of your portfolio might be invested in International Stocks.  Research by Roger Clarke agrees and comes up with a number of about 20%.  The risk is about equal to the S&P500 when you hedge the currency risk.

Out of the International allocation Mr. Opdyke recommends a 5% to 15% allocation to emerging markets.   15% of 30% is 4.5% of the whole portfolio for an upper limit.  The smaller limit is because the correlations are not low enough to offset the much higher risk.  Emerging markets volatility is around 160% of developed markets according to the article.

Commodities and currencies and other similar assets like precious metals should not exceed 5% of the portfolio in total.  This would indicate volatility similar to emerging markets.  This limit is good conventional wisdom.

So, what are you waiting for, go out and make some money!