Inspired by Rich’s latest “stock market valuation” post and the “pay off my house” thread, I am wondering what you guys think the most sensible asset allocation scheme is at the current time?

I agree with Rich that the stock market looks over-valued at the moment. And I also worried about the global equity market overall because I think the China is very close to hard landing and bring the rest of the world down with it. So I have moved my equity exposure from 100% in 2009 to below 60% recently.

However, the missing point in Rich’s post is that although an over-valued stock market only produces 6% real return in 7 years. Cash is doomed to produce negative return in 7 years. And with the possibility of new QEs, it is not 100% certain that the stock market would correct itself below the nominal value (rather in real value instead). The same goes to rental property investment. I am hesitant to pull the trigger on it while I am equally not certain that it would drop in nominal value under QE3 (though seems for sure in real value as well).

So while Rich made very compelling argument in his post, I am still clueless on how one can make sensible asset allocation plans based on that post. It seems now that the biggest risk at the moment is that the policy makers still have enormous power in changing the valuation equations between assets at any moment and there is nothing we can do and predict.