If you’ve ever heard of the phrase “don’t put all of your eggs in one basket,” then you’re in luck. It’s one of the most crucial concepts you need to learn and understand about financial planning and asset management. And once you have grasped what “not putting all of your eggs in one basket” means, you already have a basic understanding of asset allocation.
What is asset allocation and why is it a big deal?
Asset allocation in itself is self-explanatory: it’s the process of dividing your assets and investments strategically to pursue your targeted financial goals. But while it sounds simple, asset allocation is easier said than done.
When investing, asset allocation plays a significant role in working towards at your financial goals. Say you have already created an investment portfolio: there are stocks and bonds, and granted, you have your cash and cash-like assets. These are considered the three major asset categories.
Historically, the returns on these assets do not yield the same movement at the same time. If you’re not new to investment you will be aware that sometimes stocks and bonds are doing well, but the status of cash assets is not going anywhere.
Asset allocation attempts to help balance risk versus reward on your investment portfolio by adjusting a percentage of a variety of mixed assets so you can work towards your financial goals despite other economic factors.
This is what asset allocation is all about.
What is the perfect formula for asset allocation?
The thing about asset allocation is that there is not one single formula that works for everyone. Every individual investor has their own risk tolerance and time horizon, and these factors are crucial in figuring out a good asset allocation strategy.
Risk tolerance refers to the amount of investment you are willing or at least capable to lose with the prospect of having greater or better returns. This factor is strongly linked to the time horizon. Time horizon is the amount of time or period you must invest.
A longer time horizon presents a better opportunity to recover from potential losses. You can afford to take more substantial risks if given the chance—you allow higher allocation of your stocks so there is more for you to gain.
Short time horizons are a bit riskier to work with. Factors like sudden market decline can seriously affect your ability to invest and recoup losses. In the case of this, financial advisors and experts encourage asset allocation on mostly cash and like assets.
Here is a comparison: someone who is planning to make a down payment for a house in 3 years’ time will prefer an investment that has less risks, compared to someone who is gearing up for retirement planning in 20 years.
Finding the appropriate strategy for asset allocation can be tricky. Working with a financial advisor can help you get your assets sorted and analyzed.
The bottom line
Understanding and choosing the appropriate asset allocation can help your balance risk with reward given your risk tolerance. Striking the appropriate balance between assets can help you support your portfolio, keep its value, or even help grow despite stranger times.
Asset allocation does not ensure a profit or protect against loss.
Still have questions? We are here to help.
If you would like us to look at your retirement and see if you are utilizing the best possible options, we would love to meet with you and learn more about your goals to see if there is a good fit for us to work together. Reach us at 562-432-3783 or info@mbpwm.com to schedule a free introductory meeting.