Investing
Zoe Team
4 min read
Asset allocation is the process of dividing investments across different asset classes.
It is the primary driver of portfolio performance and risk management.
Portfolio allocation should be tailored to your risk tolerance and financial goals.
Asset allocation is the strategy of balancing risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance, and investment horizon.
It helps manage investment risk by ensuring your portfolio isn’t overly dependent on the performance of a single asset class, like stocks or bonds.
You should review your allocation annually or whenever you experience significant life changes to ensure it still matches your current financial needs.
In this article: Asset allocation is key to creating diversified investment portfolios that take your personal finance and investment strategy into account.
Asset allocation is how you allocate your money to different asset classes e.g. stocks, bonds, cash. The mix you pick has a big impact on both your expected return and the amount of risk you are taking. Each person has an ideal asset allocation based on their investment strategy, goals, and risk tolerance.
The overall goal of asset allocation is to achieve a certain expected return while maintaining a risk level that is in line with your risk tolerance and capacity. Including a mix of different assets in your investment portfolio allows you to diversify- you may buy large-cap stocks with a batch of long-term bonds, the idea being that the factors that cause large-cap stock prices to rise, will cause long-term bond yields to drop. They offset each other. You hedge your bets.
The mix of assets that you include in your portfolio will be divided between the different asset classes that exist. Examples of asset classes include:
Stocks Bonds Cash Commodities Real Estate Private equity As an investor, you need to decide what proportion of each asset class to include in your portfolio. Each of these asset classes has a different risk/return profile. Stocks, for example, are a riskier investment that offers higher returns. Cash, however, is a lot less risky but as a result, offers much lower returns.
Generally, assets in an asset allocation strategy differ by the kinds of companies that constitute the asset, the nature of the asset (bond, stock, etc.), the risk-reward ratio of the asset, and whether the assets behave in any particularly unique ways (such as the time decay in an options contract).
Within each asset class, you have a number of subclasses. Let’s say you decide to invest 60% of your portfolio in stocks. Great. Now you need to decide which stocks.
An example of correct asset allocation here would be balancing large-cap stocks with small-cap stocks, as well as international stocks. Although these are all growth-oriented stocks, by diversifying into different asset types you still gain the benefits of asset allocation.
Your mix of assets will depend on 3 key factors:
1 Financial Goals We all have different goals for our investments - both short and long-term. Being clear about what it is you expect or require from your investments is key as it allows you to select assets that will get you to where you want to be.
2 Risk Profile How much risk can you handle? This question must be asked and answered from both an emotional and mathematical perspective. Your risk tolerance and risk capacity will affect which assets are candidates for your portfolio.
3 Investment Time Horizon Are you a 32 year old with a long career ahead of you? Or are you a 50-year old that is heading towards retirement? The length of time that you wish to invest for is paramount to making sure that you have the right type of assets in your investment portfolio. A rule of thumb, for example, states that the younger you are the riskier you can be with your investments, as you have more time to correct downturns. But as you can see, there is no ‘one size fits all’ approach to asset allocation, as everyone’s goals, risk profiles, and time horizons are different.
As an example of a potential asset allocation portfolio, consider the following asset mix. Assume that the investor wishes to try to reduce volatility and potential downside while also hoping to not put all their eggs in one basket for their growth-assets.
20% Large Cap US Stocks
10% Small and Medium Cap US Stocks
15% International Developed Market Stocks
5% International Emerging Market Stocks
25% Long-Term Bonds
10% Short and Medium-Term Bonds
10% Real Estate
5% Private Investments
In contrast, depending on your risk tolerance and goals a more simplified asset allocation strategy can also be utilized. For example, for an investor who simply wants to reduce volatility and downside to a small degree can pursue the following asset allocation:
60% Large Cap US Stocks
40% Long Term US Bonds
There is no ‘one size fits all’ approach.
Every person’s asset allocation strategy will vary depending on your desired rate of return, your risk tolerance, how much time you have to manage your portfolio, and how much understanding you have of different assets.
In many cases, a financial planner can be of great help in guiding you through the process of selecting what mix of assets constitute the correct asset allocation for you.
Disclosures: Zoe Financial, Inc. ("Zoe Financial") is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Zoe Financial provides investment advisory services and access to independent registered investment advisers through its platform. The information provided by Zoe Financial is for educational and informational purposes only and should not be construed as personalized investment advice or as an offer to buy or sell any security. All investments involve risk, including possible loss of principal. Past performance is not indicative of future results. Clients should consult with their own financial, tax, or legal professionals before making any investment decisions. The material presented by Zoe Financial is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Material presented has been gathered from sources believed to be reliable, however Adviser cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Past performance is no guarantee of future results. Zoe Financial does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice. SEC Registration does not constitute an endorsement of Zoe Financial by the SEC nor does it indicate that Zoe Financial has attained a particular level of skill or ability. The sole purpose of this material is to inform, and it in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or service, or to attract any funds or deposits. Investments mentioned may not be appropriate for all clients. Before making any investment, each investor should carefully consider the risks associated with the investment, as discussed in the applicable offering memorandum, and make a determination based upon their own particular circumstances, that the investment is consistent with their investment objectives and risk tolerance. Lower expenses do not guarantee better investment performance. Certain information contained herein may constitute forward-looking statements. Due to various risks and uncertainties, actual events, results or the performance of a fund may differ materially from those reflected or contemplated in such forward-looking statements.
