What is Asset Allocation?

Asset Allocation divides your investments across different asset categories such as stocks, bonds and cash, to help you reach your financial goals. It's an important strategy for investors because it can help manage risk and maximize returns.

For example, let's say you want to save for retirement. You can allocate 60% of your investments to stocks, 30% to bonds and 10% to cash. This allocation would give you the potential for higher returns from stocks while also protecting your investments with the relative stability of bonds and cash.

Asset allocation isn't something you do once and forgets about; it requires ongoing monitoring and adjustments based on changes in your goals, risk tolerance and the markets. A financial advisor may assist in establishing an appropriate asset allocation and monitoring its progress to ensure it remains in line with long-term financial objectives.

Generally, the younger you are, the more aggressive you can be regarding asset allocation. This means investing more in stocks and other high-risk/high-reward investments. As you get older, you can shift your asset allocation to include more conservative investments such as bonds and cash.

Benefits of Proper Asset Allocation

Proper asset allocation is key to long-term success. It's a process of balancing the risk you take and the potential return you might earn.

Here are some of the benefits of proper asset allocation:

❑ Diversification

Allocating your assets wisely allows you to diversify your holdings among stocks, bonds and cash. If one of your investments does poorly, at least the rest of your portfolio is diversified and can make up for it. This reduces the overall risk of your investments and makes it more likely that you'll achieve your financial goals.

❑ Risk Reduction

Spreading your investments out among different types of assets is one way in which proper asset allocation can assist you in mitigating the possibility of financial loss. If you put money into stocks, you can also put money into bonds. Thus, your bond holdings might act as a cushion against the loss incurred by a stock market decline.

❑ Increased Returns

Proper asset allocation can also help you maximize your returns over time. When you diversify your investments, you can capitalize on different market opportunities. This can help increase your profits over time.

❑ Long-Term Stability

Proper asset allocation helps ensure that your investments are stable over the long term. Diversifying your investments makes you less likely to experience large swings in your portfolio's value. This helps to keep your investments safe during times of volatility.

❑ Take Advantage of Market Cycle

Another benefit of proper asset allocation is that it can help you take advantage of the cyclical nature of the markets. Investing across various asset classes allows you to ride out market ups and downs for greater long-term profits.

Types of Asset Classes

You need to know a few types of asset classes. Each asset class has unique characteristics that can help create a balanced portfolio that meets your individual goals.

❐ Stocks

Stocks represent ownership in a publicly-traded corporation and when you buy stocks in a company, you become a shareholder.

They are typically bought and sold through stock markets such as the NYSE or NASDAQ. When you purchase a stock, you will generally pay the price determined by the forces of supply and demand. This means the price will increase if more people want to buy the stock. Conversely, if more people are selling, the price will go down.

The company's performance also determines the value of the stock. The stock price will rise if the company is doing well and its profits increase. The stock price will generally fall if the company is not performing well and its profits decrease.

Capital appreciation or the rise in the value of an investment over time is another benefit that stock investing can provide. This capital appreciation can come from both the company's growth, as well as the general appreciation of the stock market in general.

Stocks also offer the potential for dividend income. Many companies pay out a portion of their profits to their shareholders as dividends. Dividends are distributed to shareholders on a quarterly basis and can provide a reliable source of income.

❐ Bonds

Bonds are one of the most common and important asset classes regarding proper asset allocation. They are a type of loan you make to a company, government or other entity and they pay you back with interest over a set period.

Bonds are an incredibly safe way to invest your money since they are backed by the issuer's ability to repay the bond, usually via taxes or other revenue streams. This makes them much less risky than stocks and other investments. Because of this, bonds tend to have lower returns but also lower volatility.

When you purchase a bond, you agree to lend the issuer a certain amount for a fixed period, typically 5-30 years. The issuer pays periodic interest payments at a fixed rate during this time.

The issuer and the current market conditions determine the interest rate you receive. At the end of the term, the issuer pays you back the principal amount you lent.

When investing in bonds, it's important to understand the different types of bonds available and the associated risks. Government bonds have lower risk than corporate bonds but offer lower returns. On the other hand, corporate bonds offer higher yields with greater growth potential, but they also come with greater risk.

❐ Cash Equivalents

These are short-term investments that can be easily converted into cash and typically have a maturity of up to three months.

Cash equivalents include:

❐ Real Estate

Real estate is a potent asset class that can help protect and grow your retirement savings. It allows you to buy and own physical property such as a house, apartment building or office building. You can rent this property to tenants, earning income through rent payments. Additionally, you can benefit from the potential appreciation of the underlying property over time.

Real estate provides several advantages for retirement savings protection. For starters, rent payments can provide a steady stream of passive income. This income can then be used to supplement other sources of income you may have during retirement. Furthermore, real estate also offers the potential for appreciation over time, meaning that if you hold onto the property long enough, you can make money when you sell it.

There are four types of real estate investments you can use to help protect your retirement savings:

❐ Precious Metals

Precious metals like silver, gold, platinum and palladium are a great asset class to include in your retirement portfolio. They are attractive, valuable and essential hedges against economic uncertainty, inflation and other market risks.

Precious metals have been utilized as a store of value for centuries and their popularity continues to this day. Gold is the most popular and well-known precious metal and is often seen as a haven asset. Silver, platinum and palladium are valuable commodities, though not as well-known as gold. All of these metals can offer protection and diversification to your retirement portfolio.

It's important to understand how precious metals work and how to buy them. You can buy physical bullion (bars and coins) and store them yourself or you can invest in gold and silver ETFs (exchange-traded funds) which represent ownership in a pool of gold and silver held by the fund. Investing in ETFs can provide a more liquid investment and make it easier to get in and out of the market.

How to Determine Your Asset Allocation

Determining the right asset allocation for your retirement savings is an important part of financial planning.

Here are some factors to consider when deciding how to allocate your assets:

Your Age

Generally speaking, the older you are, the more conservative you should be with your investments. This means investing in less risky assets such as bonds and cash, which can provide a steady income stream and protect against losses.

Younger investors may want to take on more risk by investing in stocks with the potential for higher returns but also with greater risk.

Your Risk Tolerance

How much risk are you willing to take on? Low-risk investments such as bonds and cash, are generally less volatile than higher-risk investments such as stocks, but may also produce lower returns. Moderate-risk investments such as balanced and exchange-traded funds (ETFs), can offer a good balance between risk and reward.

Your Desired Return

Are you looking for income or growth? If you're looking for income, you should focus on income-producing investments such as bonds, dividend-paying stocks, real estate investment trusts (REITs) and other fixed-income securities.

On the other hand, if you're looking for growth, you should focus on stocks and mutual funds that strive to achieve capital appreciation over time.

Time Horizon

Your time horizon is the amount of time you plan to keep your money invested. If you plan to invest long-term, you may have more flexibility in taking on the risk because you have the time to ride out any market fluctuations.

On the other hand, if you have a short-term goal such as buying a house or paying for college tuition, consider investing in less risky investments like treasury bills or certificates of deposit.

Strategies for Rebalancing Your Asset Allocation

Rebalancing your asset allocation is an effective way to keep your investments aligned with your goals and a few strategies can help.