You have set your financial goals, determined your tolerance for risk, figured out your time horizons, and have an understating of the importance of diversifying your portfolio. It is time to decide how to allocate your assets.
Many financial experts believe that determining how to allocate your assets is the most important decision you’ll make with respect to your investments. Some say that allocation is even more important than the individual investments you choose to buy.
What Is Asset Allocation?
There is no simple template or boilerplate for assets allocation. Asset allocation is an investment strategy that aims to balance risk and reward. It does this by dividing a portfolio’s assets according to an individual’s financial goals, tolerance for risk and time horizon.
This investment strategy often includes portfolio diversification. Diversifying among several asset classes is important. This is because historically, stocks, bonds, and cash have not had losses or gains at the same time. Factors that may cause one asset class to perform poorly may improve returns for another asset class. People invest in various asset classes in the hope that if one is losing money, the others make up for those losses.
For many investors, investing in a mix of the three asset categories- stocks, bonds, and cash- can be a good strategy. Let’s take a closer look at these three major asset categories.
Among the three major asset categories, stocks historically have had the greatest risk and highest returns. Stocks offer the greatest potential for portfolio growth. Their volatility makes them a very risky investment in the short term and sometimes losses can be quite dramatic. But investors who are willing to ride out the volatile returns of stocks over long periods of time are generally rewarded with strong positive returns.
Bonds tend to fall in the mid-range when it comes to risk and return. They are typically less volatile than stocks but offer more modest returns.
Hence an investor with a shorter time horizon might carry more bond holdings relative to his or her stock holdings. This is because their reduced risk would be attractive to the investor despite their lower potential for growth. There are categories of bonds known as high yield or junk bonds, which offer high returns similar to stocks, but they also carry higher risk.
Cash and Cash Equivalents
Savings deposits, certificates of deposit, treasury bills, money market deposit accounts, and money market funds fall into this category. They are considered the safest investments — with extremely low risk of loss of the three asset categories, but they also offer the lowest return. Losses in these investments are infrequent and many are even guaranteed by the federal government. The principal concern for investing in this category is inflation risk.
Within these three classes are subclasses or alternatives that can include:
- Large-cap stocks, Mid-cap stocks and Small-cap stocks.
- International securities which are issued by foreign companies and listed on a foreign exchange.
- Emerging markets which are from the financial markets of a developing country.
- Fixed-income securities, or debt securities that pay the holder a set amount of interest, periodically or at maturity, as well as the return of principal when the security matures.
- Money markets which are debt securities that are extremely liquid investments with maturities of less than one year.
- Treasury bills (T-bills) which make up the majority of these types of securities.
- Real estate investment trusts, which are a share of a pool of mortgages or properties, rather than ownership of a company.
Stocks, bonds, and cash are three main asset categories you would likely choose from when investing. But let’s not overlook other options.
You may also want to consider other asset categories including real estate, precious metals and other commodities, and private equity. These types of investments carry their own category-specific risks.
How Saddock Wealth Can Help
Creating the appropriate asset allocation model for a financial goal is a complicated task. Choosing just the right mix of assets that has the highest probability of meeting your goal at a level of risk you can live with takes time and an in-depth knowledge of what is available within each asset category. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.
Most of us have a series of financial goals as a part of a general plan that spans over time. Depending on when we start investing, our goals and needs may change over our lifetime. Perhaps you are saving for your kid’s college tuition in the short term and saving for retirement over the long term. These two goals will require different asset allocation plans to accomplish them. And once the kids have made it through college and that money is freed up, it will be important to know where to re-allocate it so that it is working for you in the best way that it can.
That’s where we at Saddock Wealth can offer you valuable assistance. We know the market. We are familiar with all of the categories and sub-categories of assets available to you. And we have three decades of experience in creating well-balanced portfolios for our clients. We are also committed. We’re here for you for the long term and look forward to serving your needs over your lifetime. Schedule a meeting with us here to discuss how we can help you manage your wealth.