Asset Allocation

Asset Allocation

What is Asset Allocation?

The idea of investing money is a foggy subject for many. This is because there is little understanding about how investments are chosen in a given account. The series of investments that one chooses for their investment portfolio is called an asset allocation.

A portfolio’s asset allocation may consist of one or two positions, or hundreds or even thousands. This all depends on the level of risk tolerance, and the desire or need for diversification. In addition, the length of time one intends to invest for.

When I develop an asset allocation for my clients, there are a few principles that must be upheld. Diversification, liquidity, rate of return focus with attention to risk mitigation, and long-term thinking are some of these principles.

Is it Important to Diversify?

It is important to diversify because you may not recover from a downturn in one company’s stock as easily as you can recover from a downturn in thousands of company’s stocks. In other words, one company may never recover, but it is incredibly unlikely that thousands of companies will never recover.

What is Liquidity?

Liquidity is the ease with which an asset or security can be converted into ready cash or another investment without fees or penalties. This is important because the market and economic situation is always changing and so your strategy should change with it.
Car Parts analogy for Asset Allocation
Rate of return paired with risk mitigation is important as well. Imagine your asset allocation is a car. You need gas and an accelerator to get you from point a to point b (rate of return). However, if something gets in your way while driving, you also need brakes, a steering wheel, and air bags (risk mitigation). A well-built car requires both efficiency of travel and effectiveness of safety and so should your investment’s asset allocation.

Finally, long term thinking; any time you’re making an investment it should be for the long term. That is what makes it an investment! If you extend your investment time horizon out through retirement, and even passed your own life in some cases, then you are more likely to stay calm during tumultuous periods and stick to the plan. Thereby, avoiding pitfalls and critical mistakes by reacting emotionally to news and market scenarios.

To summarize, when developing an asset allocation, there are many variables to consider; more even than were mentioned in this article. That is why it is important to work with competent and knowledgeable investment managers when deciding what type of asset allocation is right for you.

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