Knowing how to build a diversified portfolio can seem overwhelming. Two words that seem to go hand in hand when investing are risk and return. Asset allocation can be an investor's primary tool for managing overall portfolio market risk by apportioning investment funds among categories of assets such as cash equivalents, stocks, and fixed income investments.
What Is Asset Allocation?
Asset allocation is the subjective and ongoing process of selecting the asset classes that could meet the goals and objectives of the investor, given the amount of investment risk. The goal is to provide the highest level of return for a given level of risk. For long-term goals you will probably want to put your savings into several different types of asset classes, such as stocks, bonds, and cash. How you divide your money between these different asset classes is called asset allocation. Asset allocation does not assure a profit or protect against a loss.
What Are The Right Choices For Me?
Determining the proper allocation of your funds into the various asset classes is first based upon your risk tolerance. If you are risk averse, you would want to hold more fixed income assets such as cash equivalents and investment grade bonds and less variable value assets such as stocks. If you have a higher risk tolerance, a higher percentage of stocks would be allocated to the portfolio. The second factor in determining your asset allocation is your time horizon for the investment. You may have different time horizons in which to meet your various financial goals, such as saving for a house, starting a college fund, or planning a financially secure retirement. When you need the money and for what purpose are as important in determining the appropriate allocation as your risk tolerance. In general, short-term goals can be met with more conservative investments. Long-term goals may be achieved by taking a more aggressive approach because the money is not needed currently, therefore short-term volatility can be waited out.
Rebalancing- Keeping On Course
Over time, the holdings in your portfolio may deviate from your target allocation because of market fluctuation. Your allocation may no longer reflect your financial goals and time horizon, and you will need to rebalance. Also, as you approach the end of your time horizon and have reached your goal, you may want to assume less risk and may need to rebalance. Many of today's investment plans offer rebalancing as a tactical planning option.
There is no one correct asset allocation for everyone. One size does not fit all, allocations change with time, the economy, and profile of the investor. Deciding on the right asset allocation may be your most important decision. Carefully consider what you hope to achieve though investing before you choose the make-up of your portfolio. To help you develop an asset allocation plan, consult with your financial professional.