The Basics: Asset Allocation
Asset allocation is one of the most important decisions investors make. It’s the key to a successful long-term investment strategy, determining at least 70 percent of your return. In fact, strategically allocating your assets is even more important than closely watching and trying to predict the economy, bond market and stock market.
To put it simply, asset allocation is the process of apportioning a portfolio into different asset categories in order to balance risk and reward. Markets go up and down over time, and, as a result, so will the value of your investment portfolio. Therefore, it’s important to include a blend of investments in your portfolio, such as stocks, bonds, and cash, to ensure an optimal balancing of risk and reward.
While some investments, such as publicly-traded bonds, offer more stability, other investments, such as stocks, carry more risk. However, they also offer more opportunity for growth.
With that said, how do you decide how much of your assets to allocate to stocks, bonds or cash? The appropriate asset allocation is unique to each investor and is based on your answers to the following questions:
1. What is your risk tolerance?
One way to determine the answer to this question is to ask yourself “How did I feel during the financial crisis of 2008?” Did you immediately want to sell all your investments? Or were you comfortable letting the situation play out?
If stock volatility makes you anxious, you may consider investing more heavily in stable, fixed-income types of investments such as bonds. In contrast, if you are willing to take on more risk for the potential of higher reward, you may consider allocating more heavily in growth assets such as publicly traded stocks. The following graph shows a spectrum of asset allocation options and their related risk level.
2. What are your objectives?
Another important question to answer is “What am I trying to achieve with my investments?” For example, are you primarily saving for retirement? Are you looking for a steady source of additional income? Or are you accumulating wealth for a family or charitable trust?
If your goal is primarily income, you may decide to more heavily weight bonds in the asset allocation. In contrast, if the primary goal is the accumulation of wealth, you may choose to more heavily weight stocks in the allocation.
2. What is your time horizon?
If you have a short time horizon, you may be less inclined to accept higher risk. For example, if you have been primarily investing for retirement and are nearing retirement age, you may decide to scale back on riskier investments, such as stocks, and focus more on stable assets such as bonds, supporting the need for income as well as preserving capital in stock market declines. In contrast, if you do not anticipate needing your investment assets soon, you may decide to take on more risk, knowing that if there is a stock market decline, your investment portfolio has plenty of time to recover a loss.
Once you have determined and implemented an appropriate asset allocation you should review the decisions that led to the allocation at least annually. It is important to think about whether or not your life circumstances have changed in the past year, and, if so, whether or not your risk tolerance, investment objectives, or constraints have changed. If they have, it may be time to adjust your asset allocation.
You can’t predict the market
No one can predict the future. However one thing we can expect is that the market will continue to move up and down for a variety of reasons. A well thought-out asset allocation will help mitigate investment risk while leaving opportunity for growth.
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The information within this article is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this article are based on the views of BTC Capital Management and on information available at the time this article was prepared. This commentary contains no investment recommendations and you should not interpret the statements in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.
*BTC Capital Management is a Registered Investment Adviser and is an affiliate of Bankers Trust Company.