The Importance of Asset Allocation
So how can you get the most out of your investments? The well-known proverb, “never put all your eggs in one basket,” can be applied to all aspects of everyday life, including the way you invest your money. Almost all successful investors are very careful in building portfolios that are widely diversified. Essentially, this strategy is called asset allocation. Asset allocation is one of the most vital decisions investors make. Studies have shown that a well-structured asset allocation can determine the consistency and stability of investment returns.
Meaning of Asset Allocation
Basically, asset allocation is a strategy bent to equilibrate risk versus reward by regulating the percentage of each asset in a given portfolio. In other words, asset allocation is how you distribute your investments among the different asset classes such as bond, cash, property and share. For instance, an older investor may tend to have a lower allocation to extremely risky type of assets like shares while a younger one may decide on an elevated allocation to similar assets.
Importance of Asset Allocation
Because of the fact that various types of assets have diverse reactions to the evolving market and socio-economic and political conditions, having a well-structured asset allocation can facilitate you to cope up with variations and fluctuations of the financial market.
For instance, an investment portfolio (Portfolio A) endowed with a higher allocation to cash (e.g. 80%) than shares (e.g. 20%) will likely to do well in an adverse market conditions compared to a portfolio with elevated shares allocation. On the other hand, the same Portfolio A will not do well enough compared to another portfolio with 100% shares in an excellent share market conditions.
Procedure to Establish the Appropriate Asset Allocation
There is no sure way to establish the appropriate asset allocation for you, as an investor. This is so because a wide array of factors is involved in determining the fitting asset allocation and this includes:
- Investor’s inclination towards risks – how much temporary losses can you cope up with?
- Investor’s time horizon – how long can you resist in not using your invested money?
- Investor’s state of affairs – how much financial commitments you have?
Generally, the lesser your inclination towards risks and the shorter your investment time horizon, the smaller should be your allocation in high-risk assets like shares and property.
Age as a Factor in Asset Allocation
Age plays an important factor in structuring your investment portfolio to meet the usual standards for an appropriate asset allocation. It is vital that proper modifications should be made as you grow older and as circumstances evolve in your life. Without doubt, investment instruments that you opt for should also reflect your age and your prospective or future goals.
Asset allocation usually develops into a more traditional or unadventurous one as years pass by or as you age, which means more allocation is given to safer assets such as bonds and currencies and a lesser percentage is granted in extremely risky assets such as shares. During retirement age, it is imperative to generate some return from the assets in your portfolio to compensate the loss of income.
Examples of Investment Portfolios
- 1. Young/High Risk Investor:
65% – Shares
20% – Property
10% – Bond
5% – Cash
- 2. Middle Age/Medium Risk Investor:
35% – Property
35% – Shares
15% – Bond
15% – Cash
- 3. Retired/Low Risk Investor:
45% – Property
25% – Cash
20% – Bond
10% – Shares
Nevertheless, professionals in the sphere of investments believe that there are no established asset allocation standards for investors, adding that individual investors are in need of individual solutions in building up their investment portfolio.