Proper asset allocation is one of the best strategies for retaining wealth. An investment strategy that allows different asset classes (stocks, bonds, precious metals, etc.) to work for you is essential in helping you accomplish different financial goals.
Why do you need an asset allocation strategy?
The core benefit of asset allocation is diversification. At any given time, some asset classes are stronger or weaker than others. For example, there has been a well-established inverse correlation between stock and bond prices. When stock prices fall, as they did after the Federal Reserve and other foreign central banks lower interest rates, bond prices rise. Not surprisingly, gold also rose in value. Gold is an asset that has long been considered a safe haven in times of market volatility.
If you haven’t taken the time to rebalance your portfolio, there’s no time like the present. The strategies you employ and the asset classes you choose depend on your answers to three questions.
- How much money will you need and what mix of investments best suits your financial goals? It’s important to have the right tool for the job. A diversified portfolio should include an appropriate mix of individual stocks, mutual funds, bonds, and fixed-income investments such as money market funds or certificate of deposits.
- What is your current age/lifestyle? It stands to reason that investors who are at or near retirement age will have a different asset mix than younger investors. However, many retirees may want or need to include some growth in their investment strategy in order to maintain the lifestyle they want in retirement (i.e. travel, long-term care insurance, etc.).
- Within each investment class, what is your risk tolerance? Asset allocation and diversification is not just about blindly choosing a mix of asset classes (e.g. 60% stock/30% bond/10% cash). You have to consider diversifying within each category. For example, having your entire stock portfolio in aggressive growth stocks is a high-risk, high-reward strategy. A more risk-averse investor may choose dividend stocks, exchange-traded funds (ETFs) and index funds as more conservative options in their portfolio’s asset allocation.
What are some asset allocation strategies?
Once you answer those questions, establishing and maintaining your asset allocation requires discipline. A financial advisor or investment advisor is specially trained to help you define your financial goals and create a plan to help you achieve them. When working with a financial professional, if at all possible, you should ensure that they are a fiduciary which requires them to only make investment decisions that are in your best interests.
Make decisions with your end goal in mind
Asset allocation requires the discipline to keep your end goal in mind at all times. An investor in their 30s may have the desired asset allocation of 70% stock/20% bond /10%. However, an investor in their 60s may desire an asset allocation of 30% stock/40% bond/30% cash. Whatever the mix, investors need to monitor their asset mix to make sure it is always staying true to this goal. During times of volatility, it can be easy to get off track. Using tools such as an asset allocation calculator can help investors stay on top of their investment mix and make adjustments as needed.
Volatile markets require a more active approach
Sometimes investors, particularly buy-and-hold investors, stick with an investment strategy that is too conservative or too aggressive because they don’t want to “chase returns”. But asset allocation is not about chasing a specific return. Chasing a return is about emotion. Asset allocation is about building and retaining your wealth in a disciplined, non-emotional way.
However, in order to stay in control of their investments, investors may need to take a more active approach to asset allocation. Do you ever wonder why markets go down on a particular day, sometimes in quite a large way, for no apparent reason? In many cases, this is an example of institutional investors taking profit in order to rebalance their portfolios. Does it mean they are missing out on some potential gains? Yes, but they understand that an asset allocation strategy keeps them in control of their money instead of having their portfolio completely at the mercy of the market.
The role of market timing in asset allocation
Market timing is considered the opposite of a diversified investment strategy. However, there can be a place for it in a volatile market. Market timing is the technical analysis practice of anticipating points of support (floors) and resistance (ceilings) and executing trades that exploit these tops and bottoms. There are strategies to asset allocation, such as tactical asset allocation and dynamic asset allocation, which can include elements of market timing in an effort to take advantage of buying opportunities. For example, when the market is declining, some investors will move a disproportionate amount of money into gold to take advantage of the rising price per ounce. This approach can be successful if the investor has the discipline to bring their asset mix back into balance once their short-term objective has been achieved. The downside is that, in the event that a trade does not work out, investors may have to cut their losses.
Mutual funds can be your best friend
One of the easiest ways to accomplish asset allocation is through mutual funds (stocks and bonds) and money market funds (cash). These take the guesswork out of your investments because you can see what assets the fund is investing in and make selections based on your timeline and risk tolerance.
Another benefit of using mutual funds is that, in many cases, you can rebalance sometimes as frequently as every quarter without paying fees. In many cases, the fund will do this for you automatically. This makes it practical for the buy-and-hold investor.
A similar approach to buying mutual funds is to look for index funds that are tied to different sectors of the economy (energy, technology, emerging markets) or perhaps a group of stocks in a particular exchange (e.g. the Nasdaq 100). Rather than choosing individual stocks, these funds offer diversification by pooling your money into a basket of comparable securities.