February 21, 2015
Asset allocation is the most important concept to learn when investing money. What is it? Why is it so important to understand?
Asset allocation is the most important concept to learn when investing money. What is it? Why is it so important to understand?
Asset allocation is the mix of the investments that you hold in your portfolio. The kinds of investments that you hold will determine your returns. If you hold a very bond heavy portfolio your returns will reflect that you have less risk in your portfolio and will yield less. If you have a portfilio with a blend of stocks, bonds and REITS then you will get a balanced return that will be less reliant on one kind of investment. According to modern portfolio theory you can hold a hand full of different riskier investments and as a whole your portfolio will be less risky due to the negative correlation on many of them. You can hold emerging markets, small caps, and REITS along with your core bond and stock account and the sum of the whole will be greater then the sum of the parts, synergy working at its best. If you have a riskier portfolio you need to be aware of that and not freak out if you have a down year. That is why you hold bonds, to balance out your stocks when they are having a bad year. You want to hold a handful of different index funds so you are well diversified inside them.
Great answer, Garrett. Let’s recap.
(1) How you allocate your investments within your portfolio will tell us almost all that we need to know about your future returns.
(2) Timing the market and trying to find the right places to invest mean little to nothing. Actually, in most cases, they subtract from your actual return over time.
(3) Take your time and understand this concept better by reading any book written by William Bernstein. The Four Pillars of Investing is one of my favorite. Make it yours!