A record number of individual investors dove into financial markets in the last two years – many of them nontraditional investors with less investment experience.
With cryptocurrencies and investment apps making headlines, many felt encouraged to begin investing for the first time. As they eased in, buying only stocks from just a select few companies, often at the recommendation from a friend or social media influencer, many may have skipped a crucial step when beginning to invest: considering the risks and creating an asset allocation approach to properly diversify their investments.
Why is asset allocation and diversification important?
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.
Not diversifying enough exposes you to a great deal of risk. Properly diversifying is the key to a successful long-term investment strategy and is arguably one of the most important decisions investors make. In fact, strategically allocating your assets is even more important than closely watching and trying to predict the economy, bond market and stock market.
How to create an asset allocation approach to diversify investments
The appropriate asset allocation is unique to each investor. To determine what is right for you, start by considering these three questions.
1. What is your risk tolerance?
One way to determine the answer to this question is to ask yourself “How would I feel if the market and economy suddenly crashed?” Would you immediately want to sell all your investments? Or would you be 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.
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.
3. 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 are 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.
You can’t predict the market
If you’re new to investing, the thought of using your savings to buy a select few stocks you feel confident in may seem like an exciting new experience, but you must keep in mind that no one can predict the future.
One thing we can expect is that the market will continue to move up and down for a variety of reasons. Actively diversifying your investments with 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. This article was created for Bankers Trust Company by BTC Capital Management in its capacity as sub-advisor to Bankers Trust.