Lately (it probably has something to do with the new year, resolutions and all that), I have been thinking about asset allocation.

I've had some good discussion with a friend who has a few nifty ideas on the subject which dovetail nicely with my ultimate goal of having a portfolio that didn't require too much maintenance and, importantly, I could consider in it's entirety.  What I mean by that is that I want to have one portfolio to think about rather than a collection of strategies.

During this review process, I have thought long and hard about the role of certain asset classes in my portfolio.  I will take preferred stocks as a prime example.  These are represented with the ETF's PFF, JTP and JPS in my portfolio.  JTP and JPS are trading at steep discounts and so they represent some value to me.  PFF is different.  PFF's yield is down to about 4.8%.  This is still a decent yield and I think this asset class still deserves consideration for a place in the portfolio.  However, I do not believe there is a lot of upside in Preferred stocks as a while.  We have recovered all of the steep discounts in the securities that was created in the 2007 debacle.  So what we are left with is yield.  As we have all witnessed, the media is trying to warn us that rates are going up sometime soon.  While I have difficulty with this given that we have not seen the growth, I still must agree that the pressure is to the upside and all it would take is one surprisingly good economic number (or a high inflation number)  and rates would be off to the races on the upside.

Bonds (and bond like securities like preferred stock tends to cushion a portfolio when stocks have a rough go.  However, the correlation at this point between preferred and common stock is rising (on the downside) and falling on the upside.  When stocks do well, preferreds will earn their yield but not much more.  If we have a bad earnings spell or bad economic news stocks and preferred stock will go down.  Preferred will go down less, but I believe they will still suffer.

So, I have concluded that I should replace PFF with bonds which should go up if stocks falter.  Treasuries have the highest probability to exhibit this behavior.  I am still deciding which to go with - a fund, or actual bonds or even TIPS.

Actual bonds have the advantage that if I am wrong, they will go down in value in the near term, but ultimately, I will get my money back.  Bond funds do not have this characteristics as they are managing to a duration/maturity benchmark and the portfolio is turning over.

I will look to implement this in the coming weeks.