January 10, 2015
When someone asks you what your asset allocation is, what are they referring to? Why is it so important?
When someone asks you what your asset allocation is, what are they referring to? Why is it so important?
You asset allocation is your strategy of balancing your investments in order to lower the risk and have a better returns. It is important because if you don’t have one you could pit all your money at risk. One example would be owning 70 percent stocks and 30 percent bonds to valence out the risk.
They are referring to the percentage of different types of investment vehicles in your portfolio. Asset allocation is an important concept to understand in order to reduce the risk in your portfolio. The more broadly you can diversify your investments, the less risk you carry if one or even several of your investments fail. Asset allocation should be spread across stocks, bonds, real estate, and in some case precious metals. The other component to asset allocation is a geographic component. In addition to spreading your money across different types of investments, you should also buy those same types of investments in other countries as well. An example of a good strategy for a beginning investor willing to take on some risk would be to have 80% stocks and 20% bonds in your portfolio. In addition to this you could have 70% of your money in US funds and 30% in international funds.
Your asset allocation is the mix of your stocks, bonds and other assets along with the breakdown in the kind of stocks and bonds you hold such as international and small cap. Your asset allocation can help you balance your portfolio and take some otherwise riskier assets and hold them together to make an overall less risky portfolio. If you hold a mix of small caps and large caps as well as a mix of international and bonds you will not have all your holdings in the same area of the market. If something happens that drives the price of one area down you are protected and do not have all your eggs in one basket. Its important to diversify your holdings as much as you can and your asset allocation is how you do that. Everyone has a different asset allocation that they like so there is no perfect answer to the right mix of stocks and bonds. Some say to hold your age in bonds while others say to have between 20-30% bonds, while some younger investors may like to hold 100% stocks for the long run due to the investing time frame they have.
Once again, you guys hit this question out of the park. I have nothing to add. Well done!