Successful investing goes beyond simply putting your savings into investment accounts. Where and how you invest those dollars can significantly impact your financial future. The goal is to grow your wealth in a way that aligns with your goals and risk tolerance. Asset allocation, the practice of dispersing your investment portfolio among different asset classes, is essential for balancing risk and potential returns over time. In this article, we’ll explore some time-tested approaches to asset allocation, while also pointing out some key mistakes to try to avoid.
HighPoint Advisors, LLC has been helping clients of all ages and investment experience adjust their portfolios to keep them on their path towards personal financial independence. Serving clients in Syracuse, NY as well as cities and states across the country, we provide guidance on retirement planning, budgeting, asset allocation, as well as many other areas of financial planning for individuals and families.
What Is Asset Allocation?
Simply stated, asset allocation is the process of spreading your investments across various asset classes, which may include stocks, bonds, commodities, real estate and cash, among others. And within those broad asset classes are more specific subcategories. For example, when investing in stocks an investor may decide to invest in domestic stocks as well as international stocks. Or stocks of smaller companies as well as huge multinational companies.
One investor’s objective may vary greatly from another, so asset allocation is not a one-size-fits-all mission. As an example, an investor nearing retirement may prioritize stability and income generation in a portfolio, which could favor bonds and dividend-paying stocks. Conversely, a younger aggressive investor with a long timeframe may prefer growth-oriented investments like equities.
How to Get Started
The first step is to decide what your risk tolerance is. You’ll need to assess whether you can withstand market fluctuations, and how you feel about temporary drops in account values. Also, consider your time horizon. Longer investment timeframes may allow for more aggressive allocations, and shorter timeframes should favor stability. You may find that you have different time horizons for different individual goals. To illustrate the point, saving for retirement is likely a long-term goal, and buying a boat may be a short time horizon.
Once all that is figured out, the next step is to diversify your investments. Typically, this includes a mix of stocks, bonds, real estate, cash equivalents and other assets to spread risk across multiple asset classes. Once you’ve set portfolios in motion, remember to revisit and rebalance your allocations at regular intervals. This will help to maintain your target allocations over time.
Trusted Approaches to Asset Allocation
There are many ways to think about asset allocation. Here are some tried and true methodologies:
- Strategic Asset Allocation. A long-term method that involves establishing target allocations for various asset classes and then rebalancing the portfolio over time. It aims to maintain consistent exposure to different asset classes, leveraging their historical risk and return characteristics.
- Age-Based Rule. An old-school rule is to subtract your age from 100 to determine the percentage of your portfolio to have in stocks, with the remainder invested in bonds. For example, a 60-year-old might have 40% in stocks and 60% in bonds. This rule is considered to be more a guideline than a rule, and should be adjusted for the individual.
- Tactical Asset Allocation. A more dynamic and active strategy that allows investors to benefit from short-term market opportunities while keeping a base strategic allocation. It requires active management and knowledge of market trends.
- Modern Portfolio Theory. This focuses on building a portfolio that maximizes returns for a given level of risk. This quantitative method combines assets with different risk profiles and correlations, and allows investors to optimize their portfolios for long-term growth and stability.
- Target Date Funds. These funds automatically adjust their asset allocation as you approach a specific retirement date. Typically, the name of the individual fund will include its actual target date. They’re a convenient and simple option for investors seeking a hands-off approach, and have grown in popularity.
- Constant-Weighting Asset Allocation. This approach maintains a set proportion of different asset classes in the portfolio, and rebalancing whenever market movements cause significant deviations from these percentages.
- Age-Based Rule. An old-school rule is to subtract your age from 100 to determine the percentage of your portfolio to have in stocks, with the remainder invested in bonds. For example, a 60-year-old might have 40% in stocks and 60% in bonds. This rule is considered to be more a guideline than a rule, and should be adjusted for the individual.
Common Mistakes to Avoid
Asset allocation requires monitoring throughout the years, and there are a few areas of caution that you’ll want to be aware of. Diversifying your portfolio is crucial, but keep in mind that it is definitely possible to over- or under-diversify. Utilize different asset classes, but don’t spread the portfolio into every possible area of the markets. And make sure that you don’t have too much in any one single investment, which is called concentration risk.
Always ensure that you don’t lose sight of your risk tolerance. Being too aggressive or conservative could lead to making unfortunate emotional decisions with your money during times of market stress. Speaking of emotions in investing, never allow yourself to get too attached to any specific investment. Be objective and know when to exit an investment.
Avoid chasing performance when considering new investments. Market momentum and news headlines can put the latest hot investment right in from of your face, but don’t take the bait! Buying trendy investments that have recently rocketed higher may not end well for investors.
Lastly, don’t forget to rebalance your portfolio. Market fluctuations can skew your portfolio’s allocations over time. Whether you rebalance at set time intervals, or do it manually after major events, rebalancing will help to keep your overall asset allocation in line with your goals and risk tolerance.
Put It into Action
Whether you’re a hands-on do-it-yourself investor or prefer to work with a financial advisor, the principles of diversification, periodic rebalancing, and aligning with your risk tolerance are timeless approaches that can help you navigate the complexities of the investment world. At HighPoint Advisors, LLC, our advisors have the experience and background to help craft appropriate allocations for investors at any stage in their financial journey.
Remember, asset allocation is not a one-time decision. It’s an ongoing task that requires regular review and adjustment to ensure alignment with both your evolving financial goals as well as ever-changing market conditions.
Contact us today to start a conversation about your portfolio.
Asset allocation does not ensure a profit or protect against a loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
Investing includes risks, including fluctuating prices and loss of principal. No strategy assures success or protects against loss.
Tactical allocation may involve more frequent buying and selling of assets and will tend to generate higher transaction cost. Investors should consider the tax consequences of moving positions more frequently.
The principal value of a target fund is not guaranteed at any time, including at the target date. The target date is the approximate date when investors plan to start withdrawing their money.
Stock investing includes risks, including fluctuating prices and loss of principal. The prices of small and mid-cap stocks are generally more volatile than large cap stocks.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.