Asset allocation is fundamental to achieving investment goals. In fact, asset allocation is likely to have a bigger impact on the performance of a portfolio than the selection of individual investments.
What is Asset Allocation?
Asset allocation is the process of balancing risk and return in a portfolio by investing across different asset classes. The major asset classes include shares, property, bonds, and cash.
Maintaining a diversified portfolio can help investors prepare for shifts in the economy, providing potential to not only capture opportunities but also minimise risks of overconcentration to a particular asset class within their overall portfolio. Traditional asset allocation strategies seek to mitigate overall portfolio volatility by combining asset classes based on the individual investor, based on their goals, tolerance to risk and life stage. This is a key factor to consider when determining how one should structure their overall portfolio as it would likely not be the same for everyone.
Shares and property tend to be more volatile than bonds and cash. As such it is a question of risk versus reward when understanding where you need to invest. The simple concept of ‘high risk, higher returns’, versus ‘low risk, lower returns’ is a very simple way to describe risk versus reward. One can think of shares and property as growth assets while bonds and cash can be taught of as defensive assets.
Your investment timeframe is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because they can wait out slow economic cycles or downturns and market volatility. By contrast, an investor close to retirement who will need to access these funds over the short term would likely take on less risk because of the shorter investment timeframe and them being unable to withstand the uncertainty of volatile market conditions.
In summary, when investing, it is important to determine what asset allocation is best suited to your needs, while ensuring there is adequate diversification in your portfolio overall across a variety of these asset classes to ensure there is opportunity to create wealth while minimising the risks of volatility to achieve the best possible outcome in line with your own circumstances and objectives.