Asset allocation can be a complicated process when you’re new to investing, but by implementing the right strategies you can maximize your returns and reduce your losses. It’s easiest to think about strategic asset allocation as keeping your assets in a variety of locations, whether it be stocks, bonds, or cash.
How to Allocate
Strategic asset allocation is complicated because there’s no one allocation rule or formula for investors to follow. The mix of assets you choose is based on two main factors: your timeframe and risk tolerance. Your time horizon, or the time you have to meet a financial goal, is important to determine the amount of risk you want in your portfolio. For example, Investor A with a financial goal of retiring in a year would most likely prefer less risk. Whereas Investor B, with 30 years until retirement, would be able to take on more risk. Here is how the main investment products stack up in terms of risk:
Stocks – Although stocks are known to have the highest returns, they also have the greatest risk for loss.
Bonds – Bonds vary but generally these products offer less risk and lower returns.
Cash – Cash offers the lowest risk and lowest return of the group. This includes money in the bank, CDs, and money market funds.
The other major factor of strategic asset allocation — risk tolerance — refers to your willingness or aversion to the possibility of losing money. This means that although Investor B has 30 years until retirement they may be very risk averse. He or she would therefore choose to invest in mostly bonds and cash.
Why Strategic Asset Allocation is Important
Having a proper strategic asset allocation is the key to meeting your financial goals. Investopedia describes the importance of strategic asset allocation with the following scenario: “For instance, while one asset category increases in value, another may be decreasing or not increasing as much… it’s the best protection against major loss should things ever go amiss in one investment class or sub-class.” Therefore, having too much risk can lead to major losses while avoiding all risk can lead to insufficient returns.
Strategic asset allocation is a vital facet of a successful investment strategy. If you are new to investing, professional advice is a great way to get you on the right allocation path. A financial planner or investment manager can offer guidance about the best asset allocation strategy for your unique situation.