Why is asset allocation so important to investors? A propery allocated portfolio means that your money is spread across a range of investments. But not just any combination of assets will do; rather, a truly diversified portfolio includes assets from across multiple classes, all carefully chosen to reduce exposure to risk through low correlation.
In other words, a well-allocated portfolio achieves the right combination of risk and return for your needs.
How Does the Rational Investor Achieve Diversified Asset Allocation?
First let's define what a well-diversified and well-allocated portfolio is not. It's not designed based on hunches about this or that stock, usually gleaned from a financial media pundit. Rather, asset allocation requires research, planning, careful design, and discipline. Choosing assets is a deliberate process in which an investor chooses the assets that best match their individual financial goals and their personal level of risk tolerance.
Careful, deliberate diversification across asset classes builds protection into your portfolio. That way, if one asset class goes down, others are likely going up, thanks to low correlation between classes. This also means that well-allocated investors may not capture the entire return of the highest performing asset class, but they also won't suffer the worst losses.
Instead, a well-allocated portfolio travels the middle path — not veering in one direction or another due to market ups and downs — until reaching the investor's long-term goals, whether those are savings for the kids' education, a paid-off mortgage, or a comfortable retirement.
So what's they key to achieving optimal asset allocation in your portfolio?
Investment Guidance: Building a Diversified Portfolio
The first step toward a well-allocated portfolio lies in researching your own needs, wants and goals. Sit down with your asset management consultant and consider factors such as:
- Your level of risk tolerance
- Your tax bracket
- Your net income
- Your expenses and debt
- Your family situation
- Your time horizon
- Your specific financial goals and lifestyle goals
You'll notice that all of these factors are personal — that is, they have nothing to do with where the market is today, how the economy is doing, or that latest hot stock tip you heard on TV. Rather, the factors that determine the right asset management solutions for you are all about your individual situation and needs.
But developing a strategy isn't the difficult part. The real challenge comes with finding the discipline to stay the course and to stay on track, even as the markets rise or fall. That's where the advice of asset management firms comes into play.
By working with a trusted asset management consultant, you can take advantage of their resources, research and knowledge. By testing various portfolio configurations over time, running stress tests, and performing detailed analysis, your advisor can help you determine how your assets should be allocated. By looking at a range of potential outcomes, your asset management consultant can help you find the risk mix of assets for your individual needs and goals.
Remember: Once you've achieved a truly diversified portfolio, they key lies in being patient and maintaining the discipline it takes to ignore the noise coming from the financial media and stay on your long-term course.